If you’re like millions of investors, you’d give anything to have a crystal ball, especially when it comes to a stock like Amazon.com Inc (NASDAQ:). Obviously, I can’t give you one… but I can come close.
Today we’re going to talk about two things:
- An important bit of information most investors overlook
- How to turn what you learn into a high-probability trade
reported earnings Thursday after the bell. Ahead of that, options activity implied a monster move of 7% to 9% on the numbers. Normal earnings volatility, to put this in context, is around 5%.
In plain English, that means the stock could jump by $129.40 to $1,567.22 per share versus a more “normal” $1,437.82 per share (what it closed at on Tuesday). That means the stock would be within spitting distance of a $750 billion valuation.
To be fair, options volatility works in both directions. The move I’m talking about could take prices lower just as easily as it could take prices higher. But I don’t think that’ll happen.
I believe that the direction will be higher based on Amazon’s trajectory and its history – specifically, the company’s last earnings report on Oct. 26, 2017, which caused a 13.21% move higher in a single day.
There are any number of reasons:
- Revenue is growing at a compound annual growth rate of 23.12% over the last five years
- The fact that cash and equivalents are growing at a compound annual growth rate of 22.13% over the same period
- The company will make a number of revenue-enhancing moves within the next 12 to 24 months, including entries into both healthcare and banking that I first told you were likely a year ago
Editor’s Note: Shortly after Keith submitted this article, Amazon did in fact announce a joint undertaking with JPMorgan Chase & Co (NYSE:) and Berkshire Hathaway Inc. (NYSE:) aimed specifically at improving healthcare services and lowering costs. That means it’s time to prepare for the second part of Keith’s prediction in this area – that conventional health insurance companies get slammed as the “Amazon-effect” rolls into personalized care. He’ll have more in his next column.
We’ll come back to that in a moment.
First, I want to explain why unusual options activity is important and what to look for.
Most investors believe options are like spicy sauce on your taco… a means of introducing a little more “zip.” However, they’re missing something critical.
Options are also like a “poker tell” in today’s markets. As such, they’re frequently a harbinger of big market moves ahead in the underlying securities.
What I like about them is there’s no guesswork. Unlike stock, which exists in perpetuity as long as the company that issued it does, options come into existence only when traders make a specific choice – that a company’s stock is going to move higher or lower.
Like an involuntary twitch or a hand to the side of the head at the poker table, unusual options activity tells you that there’s big money on the move. Insiders, hedge funds, institutions, and corporate raiders all use ’em to pre-position their money ahead of major moves that can result in huge profits.
In some cases – like this one – that’s earnings, but it could also be everything from a change in business strategy to new contracts to impending news that will have a material impact on a company’s stock price. Mergers and acquisitions like those we talked about last week are also good examples.
Carl Icahn, for instance, used options to establish monster positions in both Herbalife (NYSE:) and Netflix Inc (NASDAQ:). Bill Ackman used options to build a large position in Target Corp. (NYSE:). Even Warren Buffett used warrants, a form of option, to take a $5 billion position in Goldman Sachs Group Inc (NYSE:) during the depths of the financial crisis.
Options are one of the few areas in today’s financial markets where you can play on exactly the same terms as the “big money.” For example, you can control 100 shares of an ultra-expensive stock like Amazon for as little as $55.55 a share. Imagine the kind of returns that could create versus just a single share at $1,437.82, which is where Amazon closed on Tuesday.
The other thing to think about is that options can actually reduce your risk, especially in a situation like this one. Just like the insurance on your house or your car, options can boost your profits for a fraction of the cost while minimizing the amount of money you have at risk – something straight stock trades don’t offer.
With this in mind, let’s shift gears and talk about how you find unusual options activity and what very specific tells you’ll want to look for. That way you can learn how to do this on any stock even though we’re talking about Amazon at the moment.
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