Is AMZN A Worthy Earnings Trade?

In the October 1^st issue of MarketTamer's Seasonal Forecaster, I
focused on how to trade earnings announcements. A typically higher-risk,
lower-probability trade, it can work well if you really know your stock(s) and
trade only the ones that work well with straddles. Option straddle strategies
are bi-directional trades – the trade will end up profitable if the stock moves
a certain minimum amount within the lifespan of the options. You don't have to
be right on the direction. The key phrase here is “if the stock
moves”.

Dropping in on various blogs, discussion groups, and webinars throughout the years, I've heard many stocks discussed as possible earnings release trades, and they were usually the most popular stocks.

While my interest has focused on higher probability trades, I do occasionally
consider straddle trades on earnings announcements if volatilities are down,
meaning the time values of the options comprising the straddles are lower and
therefore offering greater chances of success in the trades. Right now, the VIX
is at 14.33, pretty much the lowest level set in the past five years. There
shouldn't be high premiums in call and put prices, so this may be a good time
to do this strategy.

However, not all popular stocks make good earnings plays, even when
volatilities are down. Let's look at Amazon.com, symbol AMZN. On this chart
I've circled the last five earnings announcements. We see significant moves
after every one:

As I explained in the 10/1 newsletter, my research has shown that entering an
earnings release trade is optimum around 10 trading days before the
announcement. Often, there is a good pre-announcement move as many other
traders and institutions may be taking similar bets. From my research, I found
that most initial responses to the announcements are over within two trading
days, so that is the time period I use for backtesting. However, many trading
an earnings release for real would likely want to hang on to the trade,
especially if there was time left in the straddle options, to capture an
extended post-release move.

Focusing on Amazon's most recent 29 announcements, and the reaction of the
stock during those periods, the results look like:

Of the 29 periods, 23 of them produced moves greater than 5%. So AMZN must be
good for straddle trades on earnings, right?

What isn't apparent in the above table is if there were large swings in the
value of the straddles through those time periods. To increase your odds of
success with straddles you do not want wide swings during the holding period.
Wide swings eliminates any chance of rational trade management, such as
implementing stop-losses to minimize losses or trade adjustments to increase
the success rate of the trades.

Let's see how the five most recent AMZN trades would have worked. I simulated
likely results using actual end-of-day option prices (on typically the
expiration month options following the release date). The results were:

July 26, 2012 release (After the Market Close) – entering ten trading days
before, the straddle was down 8.4% and as high as 17.4% prior to the
announcement. Afterwards, the straddle was down as much as 18.6% before ending
with a gain of 23.4% at August expiration.

April 26, 2012 release (AMC) – The May ATM straddle was down 12.6% prior to the
announcement. Within two days afterwards the straddle was up 117.8%!

January 31, 2012 release (AMC) – The February straddle was up as much as 25.2%
and down as much as 11.8% prior to the announcement. Right after the
announcement the straddle fell to -49.2% and continued from there to end down
87% at expiration.

October 25, 2011 release (AMC) – The November straddle was down as much as
19.2% before the announcement. The first day after, the straddle was up 24.1%,
but fell right after that. Ten days later the straddle was down 40.4%.

July 26, 2011 release (AMC) – The August straddle stayed within a tight range
prior to the announcement (down 4%, up 1%). Right after the announcement it
fell 19.7%, and within 5 days was down 31.83%. However, if you had a strong
stomach and held on for the ride, the straddle did close up 81% at expiration.

I'm not even sure how to grade these results – they would vary widely depending
on whether you use stop-losses, ‘time stops' (exiting after a certain number of
days if your profit target wasn't hit), and more. If you had looked at just the
price chart, whether daily or weekly, you likely would have a good impression
of AMZN. It is a good company and a good stock to trade. However, earnings
announcements trades on this stock may not be the best way to put your trading
balance to work

Of course, there's much more you need to know and many more stocks you can
capitalize upon each and every day.  To find out more click here: www.markettamer.com/newsletters

By Gregg Harris, MarketTamer Chief Technical Strategist

Copyright (C) 2013 Stock & Options Training LLC

Unless indicated otherwise, at the time of this writing, the author has no positions in any of the above-mentioned securities.

Gregg Harris is the Chief Technical Strategist at MarketTamer.com with extensive experience in the financial sector.

Gregg started out as an Engineer and brings a rigorous thinking to his financial research. Gregg's passion for finance resulted in the creation of a real-time quote system and his work has been featured nationally in publications, such as the Investment Guide magazine.

As an avid researcher, Gregg concentrates on leveraging what institutional and big money players are doing to move the market and create seasonal trend patterns. Using custom research tools, Gregg identifies stocks that are optimal for stock and options traders to exploit these trends and find the tailwinds that can propel stocks to levels that are hidden to the average trader.