Amazon reported last night and traders loved it. For this reason, today's column highlights a long call butterfly spread trade in Amazon stock.
But first, some market background. After the Federal Reserve Chairman, Jerome Powell, gave the stock market a "KAPOWELL!" on Wednesday, traders got caught in a short squeeze.
On the back of a sizable market move recovering most of the fade in prices Thursday, strong job numbers then came over the wires Friday.
We still have to keep a close eye on the five-year Treasury bond auctions coming in March. The take-away remains: Wait for the weekly pullbacks, including in Amazon stock, to go long.
Amazon Stock Today: The Trade Setup
The long call butterfly spread is a neutral to bullish position. It estimates that prices will rise over the longer term but will also stall out at the round level of 180 in order for the trade to deliver stellar results.
Let's devise the long call butterfly spread trade in Amazon stock as follows:
- Buy to open 1 AMZN May 17-expiring call option with a 170 strike price
- Sell to open 2 AMZN May 17 180 calls
- Buy to open 1 AMZN May 17 190 call
Total debit of $1.35 per share for this trade, based on recent prices, means we get a break-even cost at 171.35 in Amazon stock. Find this by taking the price of the first long option strike plus total premium paid for the trade.
The ideal strategy result gives us four choices to exit the trade. One, sell the entire butterfly spread once it carries an acceptable profit. That's 50% to 100% for me, but price behavior will determine the move. Two, sell the entire spread in Amazon stock once it hits your loss threshold as determined by personal risk. Here, 50% for me.
Three, sell the entire butterfly spread when prices test the middle strike price of 180. Four, sell the long call spread when the middle strike price gets tested. Let the short side erode to expire worthless. Now, this strategy requires increased skill level and attention for it opens the trader to additional risk.
Amazon Stock: Defending This Trade
Stock hunting using fundamental and price strength within the IBD methodology is where I firmly plant myself under the current economic backdrop. I use technical analysis to find ideal buying opportunities in conjunction with the tools for strength seen on IBD.
The goal of taking the butterfly trade is to gain exposure to profit but to significantly limit loss if we are incorrect. Options sellers are positioned to win in two ways — the stock does nothing, or the stock moves within the ranges. So we use this concept to minimize the risk of market exposure.
Let's identify key chart levels in Amazon stock for this trade. First, the monthly support zone sits near 155, and resistance sits near 188. If we see some sharp dips, we will be in a position to potentially add to the position as long as market indicators show increased probabilities of more upside.
This will increase your risk, so think this through. Be patient in the current flow and realize that some macro events could result in volatility in the options and in Amazon stock.
Key Scenarios
Let's consider the future action as follows:
- Amazon stock dips lower but does not break 155 for more than three days. This action shows itself as favorable to traders looking for longer-term growth. Look for bounces by Amazon stock in the days following to confirm the strength of the chart.
- Stock grinds higher much earlier in the cycle and the option position increases in value by more than 100%. We could certainly choose to sell the entire position and quickly take the gains, freeing up more capital to trade.
- AMZN grinds higher and tests or breaches 180 but immediately retreats and suggests traders are not willing to pay more for the stock at the present time. This is ideal if it occurs in the near term and into the May expiration strike.
- Amazon stock breaks down in heavy volume for more than three days. This breaks our personal risk thresholds. We exit the trade.
As with all trades, consider what you like about holding the position in the first place and consider your risk carefully. Be patient and allow price action to move around a range of your stops.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of "The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology." She holds no positions in the investments she writes about for IBD. You can find her on Twitter and Stocktwits at @AnneMarieTrades
