Trading Amazon options potentially yields a staggering 42% annualized return
Amazon, the tech giant known for its Alexa-powered Echo devices and dominance in the cloud-computing market, presents an opportunity for investors seeking to generate income while maintaining stock ownership. A covered call strategy, specifically, offers a way to capitalise on elevated option premiums ahead of the Q2 earnings report on July 31.
This strategy involves selling a call option on shares already owned. By selling the call option, the shareholder can collect premium income before the earnings announcement. The described strategy uses a covered call on Amazon's stock (AMZN), starting with a delta of 25, equivalent to owning 25 shares of AMZN.
The covered call strategy performs under different scenarios:
- Stock price rises moderately (up to strike price): The investor keeps the premium and benefits from stock price gain up to the call strike. If the option is exercised, shares will be called away at the strike price.
- Stock price rises sharply (above strike price): Premium income is kept, but upside gains are capped at the strike price since shares will likely be called away. The investor may miss out on higher gains.
- Stock price falls or remains flat: Premium income provides some downside cushion, but stock losses reduce overall position value. The option expires worthless, allowing the investor to keep shares and premium.
- After earnings, implied volatility crush occurs: Option premiums decline post-earnings, benefitting option sellers as the risk premium included before earnings evaporates.
This strategy aims to generate extra income from option premiums while maintaining stock ownership, but with limited upside potential if Amazon shares surge beyond the option strike price after earnings. It works best if the stock price stays flat or rises moderately, and the premium collected helps offset downside risk.
Adding Layers to the Strategy
To further manage risk, some investors add a bear call spread or long put options to the covered call strategy. For instance, a bear call spread can be created by selling the AMZN August 15 call with a strike price of $250 and buying the AMZN August 15 call with a strike price of $255. Additionally, adding a deep out-of-the-money long put, such as an August 15 put option with a strike price of $205, can help reduce risk in this type of trade.
Current Market Outlook
As of now, 47 out of 54 analysts covering AMZN stock have a Strong Buy rating, 6 have a Moderate Buy rating, and 1 has a Hold rating. The Technical Opinion rating for Amazon (AMZN) is a 88% Buy with a Strongest short term outlook on maintaining the current direction.
The implied volatility for AMZN stock is currently 32.70%, with a twelve-month high of 63.91% and a low of 22.90%. This volatility, along with the analyst ratings, suggests a favourable market environment for the covered call strategy on Amazon's stock.
In conclusion, the covered call strategy on Amazon's stock offers investors an opportunity to generate extra income while maintaining stock ownership. By understanding the strategy's performance under different scenarios and adding layers to manage risk, investors can capitalise on the current market conditions surrounding Amazon.
- By considering a bear call spread or long put options in addition to the covered call strategy on Amazon's stock, some investors aim to further manage risk and potentially capitalize on the current market volatility.
- Given the current market outlook for Amazon, with a majority of analysts recommending a buy rating for the stock and an implied volatility of 32.70%, the covered call strategy on Amazon's stock presents a potential opportunity for investors to generate extra income while maintaining stock ownership.
