Event: Amazon (AMZN) reports Q4 results tonight after the close. The options market is implying about 8.5% one day move tomorrow, which is basically inline with its 10 year average one day move of 9%, and below the 4 qtr average of 11%. I would add that the stock rallied on all four of those last 4 prints reported in 2015, while it declined on average about 10% in all 4 quarters prior, reported in 2014.
Price Action / Technicals: AMZN is down 10% so far in 2016, basically in line with the decline in the Nasdaq Composite ytd, and down about 13% from its all time highs made in the last couple days of 2015, a year the stock closed up nearly 120%.
The two year chart below is all you need to look at in my opinion. A quick gander of 2014 shows the 4 consecutive earnings gaps, and the stock stock starting the year at its highs and ending the year very near its lows. The exact opposite is the case for 2015, starting the year at its lows and notching higher with each earnings gap, closing the year at its highs. The uptrend from last January’s lows is fairly clean, with the stock just last week testing it, the uptrend is also resting at an important support level at $550:
Fundamentals: I am going to avoid my usual rundown of fundamentals, valuation etc. They really don’t matter with this stock. What appears to matter most to investors is that the company can show their ability to be profitable, and that appears to be purely up to them.
In a note to clients, RBC internet analyst Mark Mahaney (who rates AMZN a buy with a $775 price target) said that Gross Margin trends will drive stock performance:
Critical factors for Q4 Print: In addition to fundamental results and Q1 outlook, we believe the following are critical factors.
1) Gross margin trends– Consistent and material Y/Y GM expansion has been one of the most important fundamental factors for the stock’s performance, in our view. This trend likely needs to continue for shares to move higher, and we believe it will. We estimate GMs of 32.5%, +300bps Y/Y;
2) Overall Operating margin trends– We believe Amazon’s heavy investments in international markets will weigh on profitability. We estimate 4.5% margins in Q4, +100 bps from Q4:14;
3) AWS Results– We are looking for Revenue of $2.20B (+55% Y/Y) and Segment Profit of $546MM (24.8% margin);
4) North America Retail Results– We are looking for Revenue of $21.8B, (+26% Y/Y) and Segment Profit of $1.20B (5.5% margin);
5) International Retail Results- We are looking for Revenue of $12.0B (+23% Y/Y ex-FX) and Segment Loss of $120MM
I would add that Mahaney’s $775 twelve month price target includes the following valuation assumption for AWS. equally about a third of its value for expected 2017 AWS revenues of $16 billion, or a little less than the consensus $155 billion in sales for the whole company:
And we arrive at $243 per share for the Amazon Web Services segment by using a 15x EV/EBITDA multiple on our 2017 AWS EBITDA estimate of $7.9B. We arrived at this EBITDA by applying a 50% EBITDA Margin to our $15.9B AWS revenue estimate. Our target multiple is appropriate, we believe, given our 2015-2018 AWS segment Revenue CAGR estimate of 41%.
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As you can see from the chart, implied vol (red) is significantly higher than actual vol (the daily moves in the stock) and nearly double its historical vol (pink). That makes sense into the event as the one day move is what the options must price in. But it is interesting that AMZN is at higher vol levels than it has been in the recent past, despite the fact that dollar wise, the stock is significantly higher than it was a year ago. This is fairly unique. Typically when a stock goes significantly higher it has a dampening effect on volatility as implied moves dollar wise. The opposite seems to be happening with AMZN.
Trades that incorporate being net short premium would typically be the way to play this but in AMZN, who knows. The stock is crazy and vol is high for a reason.
My View into the Print: If the company is able to beat and raise, then it could have a sort of reaction that Facebook is having today on surprisingly rosy results from an oversold condition, reversing a short term investor sentiment hit that was largely the result of broad market volatility. If the company were to miss in what should have been a seasonally strong quarter, guide to lower profitability and higher expenses, and any signs of deceleration in AWS, then the stock will be back at $500 very quickly.
Regular readers know that like FB and NFLX, this is not my cup of tea. I am predisposed to pick apart what appears to be unusually positive sentiment, and valuations that defy logic. So I am biased, but I know my bias. I suspect a relief rally to the tune of 10% is far more likely that an all out breakdown of 10% tomorrow.
Which brings me back to famed hedge fund investor Stan Druckenmiller said back in Nov about companies like AMZN, and why he is long (no clue if he still is). At the time he was “neutral and long high beta, high growth stuff, companies that are investing in their businesses, stuff that will do very well with low nominal growth and short a bunch of value companies that buyback stock and need cyclical growth against it.” As long as investors are searching for performance, high valuations of stocks like AMZN (that continue to grow) will be overlooked and the stocks will continue to be bought.
SO WHAT’S THE TRADE?
Who knows how much this stock moves on the report, but it has the potential to move a lot with the options market pricing in the potential for 9% one way or the other. For those that are long stock and want to protect against a decline of 10% or more, options prices are expensive but could be worth it in order to hold onto stock.
Defensive: Hedge vs Existing Long Stock
Buy the AMZN ($615) Jan29th weekly 600/550/500 put butterfly for $12
- Buy to open 1 Jan29th weekly 600 put for 17.50
- Sell to open 2 Jan29th weekly 550 puts at 2.95 each or 5.90
- Buy to open 1 Jan29th weekly 500 put for .40
Break-Even on Jan29th weekly Expiration (tomorrow’s close):
Profits: between 588 and 512 of up to 38, or about 6% of the underlying stock price. max gain of 38 at $550, which is about $10 below the implied move.
Losses: up to 12 between 600 and 588 & between 500 and 512, with max loss of 12 below 500 or above 600, about 2% of the stock price.
Rationale- this trade structure risks about 2% in the stock for protection of up to 6% on a move lower between down 4% and down about 15%. The break-even on the trade is 588, which is just above yesterday’s low of $580 in the stock and offers up to $38 of protection in that range.
OR
Bullish: Stock Alternative/ Replacement
Buy the AMZN ($625) February (regular) 625/700/775 call butterfly for $20
- Buy 1 Feb 625 call for 33
- Sell 2 Feb 700 calls at 7 each (14 total)
- Buy 1 Feb 775 call for 1
Break-Even on Feb regular Expiration:
Profits: between 645 and 755 of up to 55, or about 9% of the underlying stock price. max gain of 55 at $700.
Losses: up to 20 between 625 and 645 & between 755 and 775, with max loss of 20 below 625 or above 775, about 3% of the stock price.
Rationale- with options prices where they are, and the rally in the stock today, it makes sense to look to mitigate the vol crush that we will get after the results, and target the implied move, but be mindful of the prior highs near 700, which could act like a magnet on a bounce.