AMZN Bull Put Spread Part 2: Minimalism and Noise Reduction Prevail

Reducing noise intake is a much talked about and heavily emphasized concept amongst market participants. Traders and market observers often joke about bubbles forming in various market related terminology such as: black swans, flash crashes, head & shoulders technical formations, etc. I will make a mildly controversial statement: There will never be a bubble in reducing market related noise intake.

Six weeks ago I published a blog post wherein I described a bull put spread position which I had entered into on $AMZN. The main idea of option spreads is to be able to express a view on a particular stock/market and to clearly be able to quantify one’s risk and time frame. Normally, the best time to enter into call/put spreads is at times of fear/greed extremes. Selling puts when a stock enters into highly oversold territory and volatility has spiked to levels which indicate fear is usually an excellent recipe for a profitable trade. On the flip side, selling calls when a market has become exuberant and volatility readings indicate complacency is usually an excellent idea.

As you can see my timing was not perfect on the AMZN bull put spreads but, then again, it rarely is. AMZN came under heavy pressure in mid-March and tested key support in the low 160’s on multiple occasions. The bears showed up everywhere with articles on various financial websites and the StockTwits/Twitter streams were full of people calling for AMZN to break down under 160. I listened to some of this ‘noise’ because I like to keep an open mind; however, none of it swayed me from my initial position. In fact, when AMZN had become highly oversold and showed some signs of accumulation under 162, I doubled down on bull put spreads. On this second portion my timing turned out to be perfect, @NoDoji also took this trade and was quite pleased with the end result.

Here are some key principles of vanilla option spreads which I have learned to follow:

  • Enter the trade with the mindset that you are fully willing and able to suffer the maximum potential loss on the trade. If you are not capable of this then either reduce the size or don’t enter the trade.
  • Size the trade appropriately, in other words, don’t risk so much that you will become emotional when it moves against you.
  • You should almost always stick to your original plan. Remember, you entered into a position at a time when you thought the odds were in your favor, markets move around, that’s what they do. Don’t change your plan due to market noise.
  • Be aware of future market moving events (earnings, analyst days, etc.) and prepare accordingly.
  • It is usually a good idea to close out the trade when it moves far enough in your favor that the risk/reward profile is no longer compelling.

My initial entry point in the AMZN put spreads was probably only a 7.5 on a scale of 1-10 with 10 being the juiciest set up imaginable. However, the double down entry was more like an 8.5 or a 9. Let’s go to the charts:

I entered into the first half of the AMZN bull put spread trade on March 1st when the stock was trading around 170. The initial thesis being that the stock was oversold and the 167-170 support zone would hold. This turned out to be premature, and as often happens, the obvious support level was broken which set the stage for a test of major support at 160 in the coming days.

 

 

I entered into the second half of the AMZN bull put spread trade on March 23rd when the stock was trading in the low 161′s. I had been reluctant to add to the trade (adding to a loser is usually a very bad idea) due to the tumultuous market environment. On March 23rd, the Japan fears had taken a back seat and the market was experiencing a mild dip to around S&P 1285 which I believed to be a buying opportunity (and it turned out to be an excellent one). Moreover, notice that AMZN did not break the 160 level and showed signs of accumulation in the week leading up to March 23rd. I received a net credit of 2.60 for selling the April 165 puts and going long the April 160 puts, which made the second half of the trade better than a 1-1 risk/reward proposition.

Finally, AMZN rallied aggressively in the following weeks and by April 11th it was trading above 185. The time premium had bled off of the April puts and they were now well out of the money, therefore I closed the entire position for a very nice profit. It wasn’t an easy trade and it required discipline and patience, however, in the end it was well worth it.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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