Amazon.com (AMZN) put in a nice bullish candle to close out last week and is clearing resistance at 3,550.
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Amazon stock is showing a Composite Rating of 86, an EPS Rating of 99 and a Relative Strength Rating of 46. Shares are sitting above rising 21-day, 50-day and 200-day moving averages.
Implied volatility on AMZN stock is 27%, which is slightly lower than the average for the last 12 months. That means options are cheap compared with the previous 12 months.
When that occurs, it is better to be a net buyer of options rather than a seller.
One way to trade the stock from the long side in a defined-risk way is using an option strategy known as a bull call spread.
A bull call spread is created through buying a call and then selling a further out-of-the-money call.
Amazon Stock Option Premiums
Selling the further out-of-the-money call reduces the cost of the trade but also limits the upside.
Going out to August expiration, a 3,550-strike call option was trading around $117 on Friday, and the 3,600 call was around $96.10.
Buying the 3,550 call and selling the 3,600 call would create a bull call spread. The cost of the trade would be $2,090 (difference in the option prices multiplied by 100) and the maximum potential profit would be $2,910 (difference in strike prices, multiplied by 100 less the premium paid).
A bull call spread is a risk-defined strategy, so if AMZN stock closes below 3,550 on Aug. 20, the most the trade could lose is the roughly $2,090 premium paid.
Potential gains are also capped above 3,600, so no matter how high Amazon stock might go, the most the trade could profit is $2,910.
In terms of trade management, if the spread dropped from $20.90 to $10.45, or if the stock dropped below 3,400, I would consider closing early for a loss. Otherwise, I would hold to expiry.
Amazon.com earnings are set for around the end of July, so there would be earnings risk with this trade. Option prices tend to drop significantly after an earnings announcement.
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Please remember that options are risky, and investors can lose 100% of their investment. This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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