Wednesday, February 1, 2012

AMZN: Thinking sideways

When Inc. (AMZN) missed its earnings estimates after the close Tuesday, it gapped down by 10.6%, from $194.44 to $173.81.

It is up in intra-day trading but remains within a level of trading congestion set from mid-December 2011 to mid-January 2012. 

Bottom line: AMZN most likely is going to stay put for awhile. After a move of that magnitude, there's little incentive for traders to move the price a huge distance in either direction.

Enter the short iron condor.

The iron condor is an options construction composed of a bear call spread and a bull put spread, both on the same stock with the same expiration. It remains profitable within a range. If it moves above or below that range, then it becomes loss-making.

Because the iron condor is short -- there's a net credit when I open the position -- a trader typically goes for the closest expiration in the hope of keeping the premium, which is the maximum profit

The next expiration is Feb. 17, about three trading weeks away.

Looking at the chart, the previous high, before the earnings miss, was about $195, and the low before that  was about $165, although all the other lows of the congestion period were above $170.

So I want my iron condor to be profitable between those levels, and then to trail off gradually above and below them.

Here's the construction, from options expiring in February:
  • Bear call spread: Sell the $195 strike call, buy the $205 call.
  • Bull put spread: Sell the $170 strike put, buy the $160 put.
Like any position, an iron condor must be watched, and either exited or assured as the price hits the boundaries of profitability -- below $170 and above $195 in this case.

Beyond AMZN, the iron condor is a way to play large gaps, which are listed daily on many brokerage platforms. The asumption is  that after a gap, the stock will remain within a range -- out of shock, perhaps? I prize liquidity, so it's a play I use only on high-volume stocks.

Decision for my account: A short time ago I opened the iron condor described above.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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