How to Play Amazon’s Crucial Upcoming Earnings

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The next two days are going to set up at least the next two years for one of the largest companies in history.

Amazon reports its third quarter of earnings on Thursday. And this is a big one. After introducing and spending more than $1 billion in the previous quarter launching same-day and one-day delivery to many major markets across the U.S., all eyes are on what that might mean for its bottom line this quarter.

Many, including Moody’s, feel that the massive spending in the second quarter will carry through to the third quarter. Analyst Charlie O’Shea noted on his Yahoo Finance appearance that Amazon’s game-changing move to same- and one-day delivery should boost revenues this quarter – likely hitting the company’s targets. But the cost to reach those high sales figures could put a strain on margins.

Amazon has historically been very loose with its margins… sacrificing short-term profits for long-term revenue growth. After all, that’s how it became one of the three largest companies in the world. It took nearly a decade before the company saw any kind of positive earnings on its income statement.

This quarter could be a bit of a throwback to that high-growth, low-margin strategy. Obviously, the company will still have some positive EPS. It is no longer the scrapper it was in the mid-2000s. But analysts and investors alike should prepare for lower-than-expected earnings and strong sales for this quarter.

As O’Shea pointed out, it takes a lot of money to transform supply chains and moving product around to be able to deliver in a single day. That $1 billion in second quarter spending should continue as Amazon continues to ramp up this ecommerce coup.

The end goal, of course, is to outcompete the likes of Walmart and Target. Those brick-and-mortar retail giants’ only advantage on digital sales is the customer’s ability to pick up their order that same day at the companies’ physical locations. If Amazon can do the same – get product to customers that same day or at the minimum, the next day all without forcing them to drive to a store – that’s a huge advantage.

Obviously, that sets up short-term headwinds for the company in terms of investor appeal. Right now, investors are seeking out only the most stable earnings growers out there. Amazon, however, is sacrificing its short-term profits for long-term growth.

While its strategy to restructure its shipment capabilities could end up a great long-term boon for the company, investors might not like to see what it does to Amazon’s bottom line this quarter.

That could send shares temporarily down. Obviously, one way to play it would be to short shares of Amazon or buy put options on it. But have you looked at its price tag of late? As I write, the company’s stock trades at $1,773 per share. That’s a lot of cheddar to put down for a relatively small potential gain.

There is another way to get into this near-term decline, without exposing a huge portion of your portfolio to a surprise in the other direction. Let’s get right into it…

A Strategy For Short Term Bears

To buy a put option on Amazon – usually the cheapest way to short a stock – you’d have to spend $49.60 per share or a whopping $4,960 for a single put contract. That’s clearly absurd just to take a position on a relatively small dip in share price.

Alternatively, you could use a type of trade called a bear call spread. This is an ideal way to play Amazon’s impending quarterly earnings announcement.

The way this strategy works is buy selling a call option on AMZN with a strike just out of the money and then buying a second call with a higher strike price. This results in a net credit to your account, right at the start of the trade.

That credit, is the total profit potential of the trade. But the risk is also limited by that bought put option.

You can see how that works here:


Source: OptionBros

This trade is remarkable in a number of ways. First, shares don’t even have to fall for you to cash in your full profit potential. They just can’t go up in price.

Second, if shares do fall, you still profit. Sure, that profit is capped. But it costs a lot less money to get in, and your chances of locking in that profit are far greater.

Let’s look at a specific example to see how a bear call spread might play out for AMZN this earnings season.

A Specific Trade on AMZN

Right now, a trader could sell-to-open a November 15 AMZN $1,775 call for $51.30 per share and buy-to-open a November 15 AMZN $1,780 call for $48.70 per share for a net credit of $2.60 per share. Since each contract is worth 100 shares of AMZN, that’s an instant credit of $260 to open this trade.

If shares of AMZN do nothing, let alone go down between now and November 15, following this crucial earnings period, that $260 is the trader’s to keep.

Of course, any smart trader has to weigh the risks with the rewards of any trade. For this one, you can find the amount at risk by taking the difference in strike prices ($1,780 – $1,775 = $5), and subtracting that initial credit ($5 – $2.60 = $2.40). On 100 shares, that’s $240 at risk.

In other words, if shares fall or stay flat following this earnings announcement, this trader would be sitting on a return of 108.3% on the amount he has at risk. Remember, shares don’t have to do anything for him to collect that full amount. In fact, he starts with that income.

With so much focus on Amazon’s next-day delivery initiative, it would only take a tiny earnings miss or larger-than-expected cost projection to send investors temporarily out of AMZN shares. And that would result in our trader doubling his money with relative ease.

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