Updates – AMZN, GOOGL and Defined Risk

by CC May 1, 2017 2:30 pm • Trade Updates

Last week we previewed Amazon (AMZN) and Alphabet (GOOGL) earnings and detailed two trade ideas in each, one a hedge for those long and strong the stocks near highs, and bullish/ stock alternative positioning for those looking to be there for more upside, but with defined risk. With both stocks higher following the report I wanted to go over the trade ideas with an eye toward management.

First, in both stocks we detailed dollar cheap disaster protection. The idea here was to spend as little as possible, allow for unlimited upside gains, and make it easy to hold the stock through a risky event. For example, here was the GOOGL hedge:

Hedge vs 100 shares GOOGL (890)

Buy the April28th 865 put for $5

Rationale – Protects entire stock 1 to 1 below the breakeven of 860 for a fraction of the price and the implied move. Speaking of the implied move, it is about $30 in either direction, so this put is right at that level and protecting against a breakdown below.

With the stock now 933 this hedge did it’s job, costing just $5 versus the $43 in gains in the stock. Spending $5 on a hedge is money well spent if it allows for staying in the stock (versus profit taking) and letting the winner run. That sort of loss of premium could be made up with the sale of an upside call to create an over-write in between earnings.

Moving on, let’s look at the stock alternatives, starting with AMZN:

Bullish targeting $1000

Buy the May 950/1000/1050 call fly for 6.50
  • Buy 1 May 950 call for 11.50
  • Sell 2 May 1000 calls at 2.75 (5.50 total)
  • Buy 1 May 1050 call for .50

With the stock now 954 this call butterfly is worth about $13, or a double. Intrinsically it’s only worth $4 here (it’s 4 dollars above the 950 strike). So some caution is in order and a stop makes sense, in the stock if it goes much lower below the 950 strike near term or perhaps at about $10 on the trade itself if the stock goes lower or sideways and the trade loses some value. That means it would still be profitable if taken off at $10 but it leaves open the possibility for more gains if the stock goes higher from here. It can be worth up $50 so the risk/reward of seeing if the stock goes higher from here is worth it for now. However the first sign of weakness or consolidation and it’s probably worth taking profits and looking out a month or 2 for a new position.

Next, let’s look at the GOOGL trade idea:

For those looking for higher highs but not thrilled about owning the stock here with the near-term risk that entails, here’s  a defined risk trade idea targeting a move higher for a fraction of the cost of the underlying:

Bullish targeting breakout above 920

Buy the May 920/970/1020 call fly for 5.50
  • Buy 1 May 920 call for 7.90
  • Sell 2 May 970 calls at 1.25 (2.50 total)
  • Buy 1 May 1020 call for .10

With GOOGL now $933 this trade is worth about $17. It’s a bit more in the money than the AMZN trade, worth $13 intrinsically, therefore decay ($4 worth of extrinsic premium here) is not as big a factor as long as the stock is here or higher. So this is basically a delta call. So for those looking to keep defined risk as a stock alternative it makes sense to stay in the trade, with perhaps 920 as a tight stop (the breakout level) to take profits on this trade and look to roll.

In both cases we want to keep tight stops because of May expiration only a few weeks away. As long as AMZN and GOOGL are above their lower strikes patience could pay off with higher highs, but a breakdown below and the entire trade becomes extrinsic premium and is therefore at risk of being worthless in 3 weeks.