Cheap Downside Exposure to Amazon Pre-Earnings

Sunday night I shared a trade idea on Amazon.com (ticker:$AMZN) from the long side (link below). I got several comments on that trade from the Fundamental crowd about it being overvalued so this morning I am following it up with an options trade that can give some downside exposure with little or no pain, even if it continues to rise.

First let’s look at the chart for AMZN and determine some target levels. The first area to note is 168 – 173. This area has been resistance in October and November 2010, support in December 2010 and January 2011, and resistance again twice in March 2011. It also has the 171.35 Fibonacci level running through it. The next area is the 158-162 area. This was resistance in September and October 2010, and support in October and November 2010 and in March 2011 as well. This area also has the 158.82 Fibonacci level within it. The third area is the 50% Fibonacci retracement from the high at 148.70 and near the peaks in December 2090 and April 2010 Finally the area from 143-148 which was resistance in December 2009 and April 2010, as well as a gapping point higher September 2010. Using this information you can create an options trade that gives downside exposure and can get you into the stock at a much cheaper price. Checking the options deck our choices for strikes are 170, 160, 155 and 145. Using these strikes you can create a 1×2 put spread. Below is the closing board for this range for Monday April 25.

By buying the July 170 strike put and selling the July 160 strike put you create downside exposure that reaches a maximum at 160, and for a cost of $2.24. To lower the cost of this trade you can sell a downside put with the 155 strike lowering the cost to 6 cents, and giving you long exposure with a basis of 145 if the stock closes below 155 on July 15. $10 of downside exposure and then worst case you own the stock with a 145 basis at 6 cent cost. Not bad. But if the 155 level is a little tight for you then you could sell the 145 strike lowering the cost of the trade to $1.05 and giving you protection until 145 where you would own the stock with a 136 basis. Again maximum gain of $9 for $1.05 invested and the stock has to drop over 20% before you would own it 26% lower. Not a bad deal.

No excuses now. Plenty of opportunities to play in this sandbox. Trade’em well.

Top Trade Ideas for the Week of April 25, 2011: Bonus Idea

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