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Cook`s Kitchen

I did a TV appearance the other day and the financial journalist asked me where I would invest $2,500 in the market. On the spur of the moment, I recommended a moderately conservative option play with Apple (AAPL - Free Report) , where I would buy the January 375/425 call spread looking for the stock to attempt new highs above $425 by expiration.

That trade is still a work-in-progress, worth about $26 with the stock around $401. Today, I want to look at a $2,500 trading opportunity in Amazon (AMZN - Free Report) ahead of its earnings report after the close.

I'm not going to address whether the company will miss, meet, or beat its numbers today. I'm just going to give bulls, bears, and volatility traders a cheap way to play the report. Let's take a peak at the price map of this nosebleeder first.

Since this very expensive stock -- trading at a forward P/E multiple of at least 100 times -- gave lower guidance last time around and the stock got hit with corresponding earnings estimate revisions and a 20% price hair cut, I expect there will be fireworks again with today's report.

And the implied volatility that option markets are assigning to the event is looking for a pretty good move too. After the steep drops in darling high-flyers like Green Mountain Coffee Roasters (GMCR) and Netflix (NFLX - Free Report) and Wynn Resorts (WYNN - Free Report) , this is highly-warranted caution.

Right now, option implied volatility of just over 50% is suggesting Amazon could move about $33 up or down from its current price of $230 (as of noon ET), by options expiration on November 19.

This means there is a 68% probability the stock will finish between $197 and $263 by Nov 19. But that also means there is a 32% probability that AMZN exceeds these prices either way. And my strategies below will make money for a significantly lesser move.

Here are my trade suggestions:

Bulls: Buy the November 230 call for $12.75. Breakeven is above $242.75, but you should profit sooner on a quick move up.

Bears: Buy the November 230 put for $13.25. Breakeven is below $216.75, but you should profit sooner on a quick move down.

Volatility Traders: Buy the November 230 straddle (both call and put) for $26.00. Theoretical breakeven is with AMZN above $256 or below $204, but a big move either way will expand implied volatility and should increase profits immediately.

What If AMZN Stands Still?

If we don't get a big move that makes you a profit by Thursday, sell your position and take your loss. Theoretically, you could lose about $1,300 per single contract position.

But you will have time to sell your option back to the market at a smaller loss this week as even the out-of-the-money options will have time value left in them.

And my gut tells me the reward is worth the risk because a big move is more than likely coming, one way or the other.

If you've never traded a straddle around earnings season before, check out this tutorial by Kevin Matras.

Kevin Cook is a Senior Stock Strategist with Zacks.com


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