[Options] Getting Ready to Go

Sean McLaughlin
September 1, 2021

During our team's weekly strategy meeting this morning, we were chatting about how the retail sector has just been hanging in there. And don't we know it -- we've had a long puts play in $XRT (the retailers ETF) since late July that hasn't gone anywhere for us. Our thinking was this sector would be the one to lead us down if the markets wanted to trade down.

Instead, it's been hanging tough and JC remarked that it might act as "a big trampoline" for some of the notable names in the space if we start moving higher.

And of course, the 800-pound gorilla in the space is Amazon $AMZN, so if we're going to play a move higher in retailers, it makes sense to start here.

Here's a monthly candle chart of the equally-weighted Retail Index $XRT. If this sector was going to pull back, this felt like an obvious place for it to happen. But we're just not seeing it. The space is hanging so tough:

As you might imagine in this environment, $AMZN has been going pretty much sideways for a year. Just when it looked like it was about to break out this summer, the rug was pulled in early August following an underwhelming earnings report, making us wait a little longer. But $AMZN found its footing back in the middle of the past years range and held firm. And the price action of the past couple of weeks certainly confirms JC's notion of a "trampoline" floor in place here.

Though here's one major point of note: $AMZN just made a new all-time monthly closing high:

So we want to position ourselves for a breakout above all-time price highs.

JC asked me: "What's the vol look like here? Make sense to buy calls?"

My answer was some version of "Yes, we could since vol is low, but they'd be awfully expensive in absolute dollar terms."

He came back with: "Maybe we do a risk reversal then to offset the cost?" (a risk reversal is a spread where we sell a naked put in order to finance the purchase of a long call)

This too would be a sensible idea, except for one problem: selling an out-of-the-money put (even if we go $300 away from current prices) will require somewhere in the neighborhood of $40,000 in margin for a one-lot! Gulp.

If you're a big player with significant risk capital at your disposal, then both ideas above would certainly be viable options. But for the rest of us, we're going to keep our costs much more reasonable.

Here's the Play:

I like an $AMZN February 3800/3900 Bull Call Spread for an approximately $29.00 - $30.00 debit. This means we'll be long the 3800 strike call and short an equal amount of 3900 strike calls.

We think it's completely reasonable for $AMZN to target $4000/share if it breaks into new all-time highs. If this happens, then we should have plenty of opportunities to make money with this spread.

I'm going to keep the position management on this trade simple. I'm looking to double my invested capital. So any opportunity I get to exit this spread for a $60 credit, I'll take it. I don't want to hang around until February to try to squeeze more money out of it. I'll take my profits and move on to the next opportunity.

On the downside, if $AMZN doesn't move in our direction and/or reverses on us, I'll exit this trade for a loss if $AMZN can't hold the $3400 level and/or if the value of the spread decreases by 50% to about $15.00. If either situation occurs, I'll look to exit this spread to minimize any further losses.

If you have any questions on this trade, please send them here.

~ @chicagosean

P.S. We do trades like this regularly. If you'd like to leverage Best-in-Class technical analysis into smarter directional options trades, try out All Star Options Risk Free!

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