Amazon.com reports earnings Thursday after the closing bell, and the results are eagerly anticipated by the market.
Last time Amazon reported earnings, the option market was pricing in a 9.1% move and the stock moved 8.4% lower. The Q3 results, released in October, saw the stock fall 6.8% against an expected move of 10.3%.
This time around, market makers are predicting a 6.7% move for Amazon stock.
One popular trade among option traders is a short straddle that is held over the earnings announcement. This is a risky trade because it involves the sale of naked options, so it is not recommended for beginners.
The losses are potentially unlimited, so always keep that in mind.
Placing Options Straddle On Amazon Stock
Let's take a look at an example using Amazon stock.
Specifically, we'll look at a short straddle with the expiration date this coming Friday.
To set up a short straddle, traders would sell the at-the-money call and an at-the-money put. Amazon stock is trading around 106, so the at-the-money strike would be at 106.
This morning, the 106 call was trading around $3.35 and the 106 put was trading for $3.70.
Selling these two options would generate $7.05 in premium with break-even points at 98.95 and 113.05.
Market makers set option prices based on the expected move over the life of the option. Currently the implied move for Amazon stock over earnings is around 6.7%.
This is calculated as the premium of $7.05 divided by the stock price of 106.
Trade Works If Amazon Moves Less Than 6.7%
It also means Amazon stock can move up or down by 6.7% before the short straddle trade starts to suffer losses.
While the stock stayed inside the expected move the last two times, there is no guarantee that will happen again this time.
If the move is less than 6.7%, the straddle sellers win. If the move is more than that, the straddle buyers win.
Selling straddles over earnings is a popular trade for option traders. However, it's important to be aware of the risks when trading naked options.
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It's important to remember that options are 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
