Amazon.com perked up recently as it had a decisive break above its 21-day moving average. Granted, the reaction to the hot inflation report tempered enthusiasm for buying the megacap. But if the weakness is short-lived, a calendar spread is a cheap way to gain upside exposure in Amazon stock using options.
Calendar Spread Example With Amazon Stock
A calendar spread is a trade that involves selling a short-term option and buying a longer-term option with the same strike price.
Let's just use the option prices for Amazon stock yesterday to demonstrate how it works.
Yesterday, Amazon stock closed around 136. I was looking at a bullish calendar spread at 150, just above its August highs.
Selling the Oct. 21 150 call option generated around $170 in premium, and buying the Nov. 18 150 call cost around $415.
That resulted in a net cost for the trade of $245 per spread. With a calendar spread, the cost of the trade is also the most the trade can lose.
The estimated maximum profit is a little trickier. Based on this Amazon stock trade yesterday, it was around $400 but varies depending on changes in implied volatility.
Managing The Trade
The idea with the trade is that if AMZN stock trades up to around 150, the calendar spread increases in value resulting in a net profit.
The break-even prices for the trade yesterday were with Amazon stock trading around 140 and 163. However, given today's action, it might not be the time to enter into bullish trades.
I was originally looking at a drop below 125 for Amazon stock to close the trade if it was started at yesterday's prices. It nearly got there early in the trading session today.
A rally to 150 was an area I set for profit-taking. But again, since it is a directional trade, the uncertainty of the trend might warrant holding off for now.
One of the benefits of the option trade is that you get upside exposure at a lower cost. This option position for Amazon stock yesterday started with a delta of 10. That means the exposure is roughly equivalent to being long 10 shares of AMZN stock as opposed to a full contract amount of 100 shares.
With Amazon stock dropping today, the lower exposure of the option trade helps soften the blow. Even the 5% drop today led to less than a $100 loss for the trade.
Please remember that options trading is 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
