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A large unusual options position was taken yesterday in Amazon Inc (AMZN) calls that are deep in the money and expire 4 months out. This shows that the large investor has deep faith in Amazon's turnaround.
The Unusual Stock Options Report on May 23 showed that there were 1,668 call option contracts traded at $23.80 at the midpoint. This was for the $95.00 strike price call contracts that expire on Sept. 15, 2023.
That expiration period is 114 days from now or almost 4 months in the future. Moreover, since the strike price is significantly below the spot price on May 23, 2023, of $114.99 for AMZN stock, they are considered deep “in the money.”
Let's look at why a large investor would do this trade.
Why Would an Investor Do This Unusual Options Trade?
First, it makes sense from the standpoint of having a bullish outlook on AMZN stock. This is a cheaper way of buying the shares and effectively leverages the institutional investor's capital.
We discussed the company's outlook in our recent article on May 21, “Amazon Stock Continues To Slowly Move Higher, Reflecting Faith In Its Free Cash Flow.” For example, confidence is rising that Amazon will produce a positive free cash flow (FCF) quarter in the near term.
Last quarter Amazon had a negative FCF result of $3.3 billion in the trailing 12 months (TTM) to March 31. That was much better than the prior year's $18.8 billion outflow. Confidence seems to be rising among analysts that it will produce a positive FCF quarter or close to it either for the June 30 quarter or the Sept. quarter.
That could be why the investor took a call option position in the Sept. 15 expiration period.
Second, this is a good way to conservatively leverage the investor's capital. For example, since the call option is deep in the money, it has lots of intrinsic value. For example, $114.99 less the strike price of $95.00 results in an option premium of $19.99 - i.e., the intrinsic value. As the investor paid $23.80 for the call options, that is only $3.81 over the $19.99 intrinsic value, or 19% of extrinsic value.
Another way to look at is 81% of the call premium paid has real intrinsic value. Moreover, if the stock rises by just 3.3% by Sept. 15, 2023, (i.e., $3.81/$114.99) the investor will have covered their bet with 100% intrinsic value.
The Leverage Effect
In effect then they can leverage their investment much easier. For example, let's say that the stock rises by 10% to $126.49 on or before Sept. 15. That 10% gain in the stock represents a price increase of $11.50 ($126.49-$114.99) on top of the $19.99 intrinsic value today.
In other words, the call option investor will have an option that is worth at least $31.49, or a gain of 32.3% on the original premium cost of $23.80.
Moreover, the call option will likely have at least $3.00 in extrinsic value. So it would trade for $34.49 if the stock moves up 10% to $125.49. That represents a potential return of 44.5% (i.e., $34.49/23.80).
So, you can see that with 1,668 call options traded the investor has invested almost $4 million (i.e., $1,668 calls x 100 x $23.80 = $3.968,840), and stands to make 44.5% or $1.766578 million if AMZN stock rises by just 10% on or before Sept. 15.
This is a much better return, i.e., a leveraged return, if the investor had put $4 million in AMZN stock and made just $400K if AMZN stock rises by 10%. In effect, the leverage is 4.4x with this small move in the stock. That is likely why the large investor made this trade.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
