Last summer saw a truly remarkable milestone in the history of stock trading. Apple and Amazon both hit $1 trillion in market cap. Of course, we all know what happened after that.
Stocks across the board fell throughout the second half of 2018. Tech stocks had an especially difficult year end.
But history repeats itself. Stocks have again soared so far this year. Tech stocks, again, lead the rally. Right now, today in fact, Amazon is repeating its testing of a $1 trillion market cap. Microsoft surpassed that market itself recently.
The question we must ask, therefore: will we see another repeat of last year’s $1 trillion top?
The problem with analyzing a company that has a value in the 13 digits is that no single problem or breakthrough can be big enough to really dent its current business – for good or ill. No successful product launch or marketing failure can truly change the course the overall company is on. It’s just too big.
So, when trying to answer this question – specifically for Amazon – we have to look beyond its quarterly income statement and analyst estimates. The only way to analyze price movements for such a behemoth is to look at what investors themselves are doing.
For instance, consumer sentiment – an often discussed but rarely understood market element – is a major piece of this trillion-piece puzzle.
This is a difficult thing to measure. It’s not like sales or production. It is an emotion, not a data point. That hasn’t stopped those in the market from trying to measure it.
The only way to measure sentiment at all is by asking people what they feel. That’s what the University of Michigan Surveys of Consumers does. The results form the University of Michigan Consumer Sentiment Index:
As you can see, the latest survey puts the overall economic sentiment by consumers right where it was last summer. But note the freefall that corresponded with the rest of the market:
These charts look pretty similar. But as you can see, just looking at consumer sentiment wouldn’t have helped predict any of this movement. It is, as they say in the industry, a lagging indicator. That doesn’t mean it’s useless. At least on a company-specific basis.
Again, let’s go back to Amazon. The company is about to hold its annual Prime Day. This Christmas in July event offers extreme discounts on a huge number of products on Amazon, available only to Prime members. The idea is that these deals will entice those without memberships to sign up for the $100-per-year subscription. Once in, few ever cancel.
Each year the company has done this, it’s seen both memberships and sales grow at remarkable rates. Last Prime Day, the company booked $4.2 billion in sales up from $2.4 billion the year prior. Regarding sentiment, if the company doesn’t see a similar increase to at least $6 billion in this 48-hour sales window, investors will be disappointed.
Now, that sounds like a lot, $4.2 billion or $6 billion is a lot of money… but not really. It’s nothing compared to the company’s annual $233 billion in sales. But sentiment is more important here. Not the actual effect a two-day sale will have on annual revenue… but the general consumer opinion on what Amazon has to offer.
And there’s reason to believe this year’s Prime Day could disappoint. A massive strike of workers is being called for an important fulfillment facility in Minnesota. Recent news stories on the poor conditions at these facilities are gaining more exposure. And second annual boycotts are being spread about online.
In short, there’s a good chance Amazon could see a short-term top in price if any of these start affecting sentiment. Then, of course, you have the company’s stock chart itself to show you all you need to know:
As you can see, this second attempt at surpassing the $ 1 trillion market cap mark coincides with the top end of its trading range. At the bare minimum, we should see shares take a breather for the next few weeks. And that’s exactly where today’s trade opportunity comes in.
A Strategy For Short Term Bears
A bear call spread is a type of options trade that takes advantage of sideways or downward price movement.
Instead of using puts, this kind of trade uses call options. A trader will sell a slightly out of the money call option on a stock he believes isn’t likely to rise in price and buys a second call option with a higher strike for protection.
The difference in option premiums is the profit potential. The risk is found by taking the difference in strike prices and subtracting that initial income.
You can see how this strategy works here:
Source: The Options Industry Council
As you can see, the profit potential is limited – to the amount received right up front. But so is the risk. As opposed to just selling a naked call, with unlimited downside potential if shares rise, this strategy caps that risk with the long call.
Let’s look at a specific trade on AMZN to show you how this type of trade could be used with today’s situation.
A Specific Trade on AMZN
Right now, a trader could sell an August 16 $2050 AMZN call for $58.95 and buy an August $16 $2060 call for $53.74 for a total credit of $5.21 per share. Since each call represents 100 shares of AMZN, that’s a total income of $521 for this trade.
That $521 hits the trader’s account the moment the trade processes. That’s also the most he stands to gain for the full duration of this trade.
However, to keep that full amount, shares of Amazon don’t have to do anything. They can even go up slightly in price, as long as they don’t rise above $2050.
This is different than how most other trades work. Normally, profits are calculated on how much a stock moves while the trade is open. This type – a credit spread – works even when the stock itself doesn’t move.
It doesn’t come without risk, however. To find out just how much the trader would have to lose in case of a continued AMZN rally, take the difference in strike prices ($2060 – $2050 = $10), and subtract that initial credit ($10 – $5.21 = $4.79). On 100 shares, that’s a total risk of $479.
In other words, this trade represents a 109% potential return on the amount at risk. Considering shares don’t even have to fall – which they should in the short term – to keep that full return, that’s a pretty good deal.
Now, I’m not saying that shares of Amazon are doomed to repeat last year’s collapse. But this expected breather in their current rally presents a better than 2-for-1 return on risk. For a $1 trillion company, that’s a rare opportunity.