Yesterday, as Facebook (FB) was putting in the largest one day market cap decline in US stock history, we looked ahead to fellow FANGer Amazon (AMZN) and the asymmetrical risk reward into its print. Here’s what Dan wrote yesterday:
But I did get a question from a friend who recently told me that in the last couple months has added significantly added to his AMZN position asking what I thought. He has owned his core position for a very long time and obviously has large gains. So regular readers probably know where I am going with this… how could you feel comfortable staying long, while defining your risk, while also having potential upside gains out of the print tomorrow? Using options you can what we call collaring your stock…. for instance,
VS 100 Shares of AMZN long at $1820 you could buy the July 27th weekly (tomorrow) 1880 / 1765 collar for even money
-Sell to open 1 1880 call at $24
-Buy to open 1 1765 put for $24
The idea for the collar is to look for something that doesn’t cost money, potentially gives up some profits above the expected move, but protects against the unforeseen below, like we saw in Facebook. This is a great strategy in a position that is a winner and a long term holding as it allows to hold the stock through potentially volatile events and not face the bias of wanting to book profits too early.
Amazon is indeed higher today but the move is well within the range expected, up just $35 versus the $90+ move the options market was pricing.
With the stock now 1843 the collar is still basically zero and barring some late day surge the 1880 calls will not come into play and therefore the entire protective overlay can be left to expire worthless. The collar did it’s job, the stock is higher but not high enough that any profits were sacrificed and it allowed o hold the stock into earnings with defined risk below in case the stock pulled a Facebook.