We're right in the thick of earnings season, and Amazon stock is holding near highs.
While it can be a risky time for option traders, there is also a lot of opportunity. Amazon.com reports Thursday after the close, so let's look at the past earnings moves compared to the expected move.
Amazon stock has moved lower following four out of the last six earnings announcements.
Three times, the stock has moved more than the expected range — twice on the downside and once on the upside.
The expected move for the upcoming release is around 4.4%.
One popular trade among option traders is a short straddle that is held over the earnings announcement.
But this is a risky trade because it involves the sale of naked options, so it is not recommended for beginners. Amazon options are also very high in value, so losses could potentially be huge.
For beginner traders, a much better idea is to stick to risk-defined trades such as vertical spreads or even iron condors.
Amazon Stock: Iron Condor
Let's see how an iron condor might be structured around Amazon's earnings announcement.
First, we take the bull put spread. Using the July 30 expiry, we could place the put spread at 3500-3490 by selling the 3500 put and buying the 3490 put. That spread traded on Friday for around $1.95.
Then the bear call spread could be placed by selling the 3800 call and buying the 3810 call. This spread was trading around $2.50 on Friday.
In total, the iron condor will generate around $4.45 in premium.
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The profit zone is if Amazon stock stays between 3495.55 and 3804.55. This is calculated by taking the short strikes and adding or subtracting the premium received.
As both spreads are $10 wide, the maximum risk in the trade is $10 – $4.45 x 100 = $555.
Healthy Return
Therefore, if we take the premium divided by the maximum risk, this iron condor trade can return 80.18%.
That's a very nice return, but as we've seen in the past, Amazon stock could move by more than the expected range, seeing the trade suffer a full loss.
There is no opportunity for adjusting with such a short-term trade, so it's a hit or miss type trade.
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And of course, if traders think Amazon stock might move more than expected, they could do the opposite and buy the iron condor.
Remember options are risky. 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
