If Amazon Doesn’t Move Much, You Pocket A 28% Return On This Trade

Amazon (AMZN) dropped more than 50% in the last year, leaving investors to wonder: Is the pain over? For traders who think the price of Amazon stock might stabilize here, an iron condor option trade is a way to profit.

According to IBD Stock Checkup, AMZN stock is ranked No. 13 in its group and has a Composite Rating of 42, an EPS Rating of 65 and a Relative Strength Rating of 13. But today, it’s getting above its 50-day line for the first time in four months.

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How To Set Up An Iron Condor

Iron condors are best placed when a trader has a neutral outlook on the stock and does not expect volatility to rise. It’s a combination of a bull put spread and a bear call spread. The idea with the trade is to profit from time decay while expecting that the stock will not move too much in either direction.

To set it up for Amazon stock, let’s start with the bull put spread. Using the Jan. 27 expiry, we could sell the 83 put and buy the 78 put. That spread traded for about 60 cents yesterday.

For the bear call spread on Amazon stock, use the same expiration for the trades. In this case, selling the 98 call and buying the 103 call brought in 50 cents of premium.

In total, the iron condor generated around $110 in premium.

The profit zone ranges between 81.90 and 99.10. You get this calculation by taking the short strikes and adding or subtracting the premium received.

Managing The Option Trade For Amazon Stock

The maximum profit will be the $110 premium received. Ideally, time decay works in your favor and all the options expire worthless. In that case, you keep the entire premium. If you finish below 81.90 or above 99.10 at expiration, you lose money on the trade.

Once you get beyond the long strikes at expiration, below 78 and above 103, your loss is maxed out. The maximum risk in the trade $390. That’s found by taking the difference of the strikes (5 for both spreads) and subtracting the premium of 1.10. The calculation is 5 – 1.10 x 100 = $390.

Therefore, if we take the premium ($110) divided by the maximum risk ($390), this iron condor trade on Amazon stock has the potential to return 28.2%.

If price action stabilizes, then iron condors will work well. But if AMZN stock continues to bounce around, the trade will suffer losses.

One way to set a stop loss for an iron condor is based on the premium received. In this case, we received $110 so could set a stop loss at 1.5 times the premium, or around $165.

Please remember that options are risky, and investors can lose 100% of their investment.

This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.

Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ

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