Barron\'s - 21.10.2019

October 21, 2019 BARRON’S M7

The Striking Price

Options

How to Play Amazon’s Earnings

By Steven M. Sears

THERE’S ONE THING THAT EVERYONE SEEMS

to agree on in this angst-driven market:

Event-driven trading is looking increas-

ingly attractive.

Bywageringontheoutcomeofearnings

or economic reports, investors generally

have, at minimum, a 50/50 chance of being

right—pretty good odds, considering that

everyoneisstrugglingtounderstandwhat’s

going on at a time when a presidential

tweetcouldatanymomentprovetobethe

iceberg that sinks the Titanic.

Theseconditionscreateaperfectoppor-

tunityforoptionstrading.Ratherthancom-

mittingbucketsofcashtobuyastock,inves-

torsaredecidingtoriskalittlebitofmoney

topotentiallygainalotiftheirputandcall

trades are winners. (Puts increase in value

whentheunderlyingsecuritypricedeclines,

whilecallsincreaseinvaluewhentheunder-

lying security price increases.)

This is especially true as third-quarter

earnings season begins. Now, it seems,

barely a moment passes without someone

buyingrelativelyinexpensiveupsidecalls—

or selling plump downside puts—to try to

make some cash off an earnings report.

Stuart Kaiser, UBS’ derivatives strate-

gists, has advised clients that investor ex-

pectations are fairly low for earnings sea-

son. You can thank lingering concerns

aboutthetradewarwithChina,andthrow

in the standard worry that the U.S. econ-

omyisdancingaroundtheedgeofareces-

sionaryvolcano,forkeepingearnings-per-

shareestimatestampeddown.Still,options

dealers are a shrewd bunch, and Kaiser

notes that most options are fairly priced

aheadofearnings,makingfindingpotential

mispricings more difficult than normal.

According to Goldman Sachs, Ama-

zon.com (ticker: AMZN) offers potentially

mispricedoptionsandstrongearningsfun-

damentals. The bank has told clients that

Amazon’sstockispricedintheoptionsmar-

ketasifitwillmove4%inreactiontoearn-

ings, compared with an average earnings-

day move of about 5% for the past eight

quarters. The company reports on Oct. 24.

Goldman analyst Heath Terry, who fol-

lowsthee-commercegiant,istellingclients

thatthestockshouldadvance40%overthe

next12months.Theextraordinarymovere-

flects Amazon’s dominant position in cloud

computing, as well as the continued death

march of its traditional retail competitors.

Goldman’sderivativesstrategistrecently

told clients to buy Amazon’s November

$1,725callswhenthestockwasat$1,720.26.

The stock has since surged. Investors who

areintriguedbytheAmazonearningsplay

can simply buy November calls with strike

pricesthatareslightlyhigherthanAmazon’s

stock price to position for a rally.

Shouldthestockbehaveasexpectedby

Goldman, the trade will prove profitable if

thestockisabovethecallstrikepriceatex-

piration. During the past 52 weeks, the

stock,whichisup17%thisyear,hasranged

from $1,307.00 to $2,035.80.

While owning calls intoearningsispopu-

lar,manyinvestorsprefersellingdownside

puts on Amazon to generate attractive re-

turns on cash. Amazon’s put premiums are

expensivebecausethestockpriceissohigh.

Ofcourse,theriskofsellingputsonsuch

a high-price stock cannot be overstated. If

Amazondeclinesonearningsandthestock

isbelowtheshort-putstrikepriceatexpira-

tion,putsellersmustbuythestockorcover

the put. At $1,750, 100 shares of Amazon

costabout$175,000,whichisrealmoney—es-

peciallyconsideringthatsellingtheNovem-

ber$1,740putgeneratesonlyabout$5,000.

Some will criticize Amazon put sales as

picking up a nickel in front of a steam-

roller—and they wouldn’t be wrong. Of

course, if the put trade works, pocketing

$5,000fortyingupidlecashisanicereturn

for not much work.

OneinvestorwholikestheAmazonput

tradesaysitoftenworks,andeventhough

heoccasionallyhastobuystock,everything

tends to work out over the long term. If

thisappealstoyou,butyouwanttotemper

theputtrade,waitfortheearningsreport

tobereleasedandthensellputs.Why?The

stockshouldbemoredocileonceallofthe

news is out of the way.

Equity Options

CBOE VOLATILITY INDEX

VIX Close VIX Futures

10

15

20

25

30

35

40

NDJ FMAM J J A SO

Daily Values Source: CBOE

THE EQUITY-ONLY PUT-CALL RATIO

Put-Call Ratio S&P 500 Index

50

85

120

155

190

225

260

NDJ FMAM J J A SO

Source: McMillan Analysis Corp.

SPX SKEW

Implied volatility %

8

9

10

11

12

13%

NDJ FMAM J J A SO

Source: Credit Suisse Equity Derivatives Strategy

NDX SKEW

Implied volatility %

8

9

10

11

12%

NDJ FMAM J J A SO

Source: Credit Suisse Equity Derivatives Strategy

Skew indicates whether the options market expects a stock-market advance or decline. It measures the difference

between the implied volatility of puts and calls that are 10% out of the money and expire in three months. Higher

readings are bearish.

Week'sMostActive

Company Symbol TotVol Calls Puts AvgTotVol IV%ile Ratio

Achillion Pharm ACHN 131736 67922 63814 1952 72 67.5

Assembly Biosciences ASMB 2216 1238 978 84 81 26.4

Badger Meter BMI 6768 3266 3502 596 54 11.4

Gossamer GOSS 20281 3664 16617 2724 71 7.4

Sleep Number SNBR 31375 16111 15264 4316 22 7.3

Royal Bank of Scotland RBS 8780 7098 1682 1332 92 6.6

Ericsson ERIC 30273 27025 3248 4836 7 6.3

Limelight Networks LLNW 6706 4922 1784 1068 42 6.3

Crown Holdings CCK 24079 15394 8685 4044 50 6.0

Exelon EXC 46576 36500 10076 7744 84 6.0

Endo International ENDP 44621 36883 7738 7480 100 6.0

Reata Pharm RETA 18202 9184 9018 3076 92 5.9

New Age Berages NBEV 53977 43702 10275 9680 54 5.6

Simply Good Foods SMPL 3083 2686 397 632 91 4.9

Ultra Clean Holdings UCTT 5218 1509 3709 1056 57 4.9

Interactive Brokers IBKR 13259 5389 7870 3124 74 4.2

Teekay Tankers TNK 13419 13152 267 3424 100 3.9

Aurinia Pharm AUPH 41662 34890 6772 10704 99 3.9

Signet Jewelers SIG 73987 54972 19015 19420 72 3.8

Sage Therapeutics SAGE 27824 26667 1157 7588 87 3.7

Thistableofthemostactiveoptionsthisweek,ascomparedto average weeklyactivity–notjustrawvolume.Theideaisthatthe

unusuallyheavytradingintheseoptionsmightbeapredictorofcorporateactivity–takeovers,earningssurprises,earningspre-

announcements,biotechFDAhearingsordrugtrialresultannouncements,andsoforth.Dividendarbitragehasbeeneliminated.In

short,thislistattemptstoidentifywhereheavyspeculationistakingplace. Theseoptionsarelikelytobeexpensiveincomparisonto

theirusualpricinglevels.Furthermore,manyofthesesituationsmayberumor-driven.Mostrumorsdonotprovetobetrue,soone

shouldbeawareoftheseincreasedrisksiftradinginthesenames

RatioistheTotVoldividedbyAvgTotVol.IV%ileishowexpensivetheoptionsareonascalefrom0to100.

Source:McMillanAnalysis