Options Corner: Economic Uncertainties May Have Favorably Mispriced Amazon’s Call Options – Amazon.com (NASDAQ:AMZN)

While diversification is often considered a golden strategy, it can also be a headwind under certain circumstances. Just take a look at Amazon.com Inc (NASDAQ: AMZN) as a clear example. As a technology juggernaut, Amazon is clearly a player in the push for the digitalization of everything. However, AMZN stock is only up around half-a-percent this year. You can blame the tough environment in retail. Still, the security may offer a compelling look for aggressive speculators.

On surface level, the fundamentals don’t appear conducive for AMZN stock. Earlier in the week, Oxford Economics lead analyst John Canavan stated that while he’s cautiously optimistic about the U.S. economy, the market could be excessively ambitious regarding the dovishness of the Federal Reserve. Per Canavan, the benchmark interest rate might be cut only one more time this year, not two.

On another note, the Bureau of Labor Statistics negatively revised jobs data, suggesting a weakened consumer base. Adding to this narrative is the latest earnings print by Costco Wholesale Corp (NASDAQ: COST). While the retailer beat expectations on the top and bottom lines, same-store sales represented a major concern. Despite the 6.4% growth rate excluding fluctuations tied to gas prices and foreign exchange rates, this figure marked two quarters of deceleration.

Still, amid the rough data, there are key positives to consider that could potentially boost AMZN stock. First, regarding Costco’s earnings, e-commerce sales increased by 13.5% against the year-ago quarter’s result. This growth rate suggests that online transactions represent a critical pathway for the modern consumer — an element that obviously favors Amazon.

Second, the latest data from U.S. Bureau of Economic Analysis showed that the Personal Consumption Expenditures price index — the Fed’s go-to inflation metric — rose 2.7% year-over-year in August. That remains an elevated figure, which has caused concerns about forward monetary policy. At the same time, the figure was also in line with economists’ expectations, which could be viewed as a positive.

Using Risk Modeling To Extract An Opportunistic Trade In AMZN Stock

One of the key advantages of trading AMZN stock on the long side is that the underlying business is an economic stalwart. People nowadays can’t live without its many services, from e-commerce to cloud computing to even groceries. Subsequently, like the benchmark S&P 500, AMZN enjoys an upward bias.

However, this northbound tendency stems from the aggregate behavior of all price action. My theory, though, is that certain sentiment regimes create return profiles that push beyond (or below) normal expectations. What’s more, the shift in regime may be signaled ahead of time through quantitative sequences.

For instance, AMZN stock is printing an unusual sequence that no one else (to my knowledge) is talking about. In the trailing 10 weeks, there have been six up weeks (defined as the return from Monday’s open to Friday’s close) and four down weeks, with an overall downward trajectory. Ordinarily, you would expect an accumulation-heavy sequence to be bullish but in this case, AMZN is tilted bearishly.

Since January 2019, this rare sequence has only occurred nine times so it’s difficult to express statistical confidence from it. Still, what’s interesting is that in seven cases, AMZN stock has moved up relative to the anchor price (starting point) over the next five weeks.

Further, the median price of outcomes associated with the 6-4-D sequence comes out significantly higher than the median price of all outcomes. Essentially, AMZN stock could move higher than what Wall Street is anticipating, thus making vertical options spreads potentially underpriced.

This methodology of finding mispriced opportunities is very similar to risk management, specifically insurance. But rather than attempting to find the probability of a hurricane materializing and how much damage it could potentially cost, we’re trying to figure out the likelihood of probability relative to our anchor price — and then determining the potential magnitude (reward).

To be clear, it’s hardly a foolproof approach. In many ways, it’s easier to predict hurricanes because that’s science. The stock market? Because of the potential for exogenous factors to disrupt the paradigm, the fluctuations can be pure madness. Nevertheless, using risk-management protocols integrated with Markovian principles offers an empirical basis for speculation.

Calculating An Aggressive Bull Call Spread

Over the next five weeks, the median price of outcomes associated with the 6-4-D sequence is projected to land at a bit over $230. This is the 50th percentile, meaning that half of outcomes in the dataset would land above $230 and half below. Enticingly, market makers don’t view this price point as a particularly reasonable target — but the empirical evidence suggests otherwise.

Under this speculative framework, the 225/230 bull call spread expiring Oct. 31 appears to be the most enticing trade. This transaction involves buying the $225 call and simultaneously selling the $230 call, for a net debit required of $200 (the most that can be lost).

Should AMZN stock rise through the second-leg strike price ($230) at expiration, the maximum profit would be $300, a payout of 150%. Breakeven lands at $227, which is 3% above the time-of-writing price.

Again, the sample size of the 6-4-D sequence is super small so it’s impossible to have supreme confidence in the trade. Still, the unusual nature of the counterintuitive quant signal makes AMZN stock worth consideration.

The opinions and views expressed in this content are those of the individual author and do not necessarily reflect the views of Benzinga. Benzinga is not responsible for the accuracy or reliability of any information provided herein. This content is for informational purposes only and should not be misconstrued as investment advice or a recommendation to buy or sell any security. Readers are asked not to rely on the opinions or information herein, and encouraged to do their own due diligence before making investing decisions.

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