Netflix, Apple, Amazon Options Trades Ahead of Earnings

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- This week kicks off the truly exciting portion of earnings season. It does not get much better than Netflix ( NFLX), Apple ( AAPL) and Amazon.com ( AMZN) all reporting in the same week.

Investors really need to start treating these conference calls like soccer matches and Stanley Cup Playoff games. Invite over some friends. Stock the fridge with beers. Order up a few pizzas. Sit back, relax and enjoy what truly amounts to suspense and excitement.

As Jim Cramer mentions on a regular basis, if you're a current or prospective shareholder, you need to listen to these calls, entertaining or not. Even if you have no stake, even a ho-hum earnings call can provide a worthwhile learning experience.

There's nothing more unsettling than being in an options trade, particularly a directional one, ahead of earnings. That makes the release of the report as well as the conference call all the more meaningful. It probably should not be nerve-racking, but, let's be honest, most traders and investors do not have the emotionless, cool and disciplined head you need to have when making inherently risky and relatively speculative trades. Moreover, most folks who dabble in short-term speculation do not have a statistical "edge" and, worse yet, they tend to enter the lowest of low-probability trades during the most volatile times (e.g., earnings).

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There's an easy answer to all of this: Do not get yourself into low-probability options trades ahead of earnings. Even though they're a disaster waiting to happen, people pile into them on a quarterly basis. Why? The allure of the "cheap" out-of-the-money option is just too much to resist.

In this article, I discuss trades not to make ahead of Netflix, Apple and Amazon earnings. I consider ones that make more sense. Some involve covered calls, a topic I expand on in Tuesday's issue of my Options Investing Newsletter. Covered calls often represent the best way to use options for beginners and experienced investors alike.

Amazon and Apple

Let's start from the last company of the three to report this week -- Amazon.com. Amazon is on deck Thursday. I am bullish long-term on the company and stock, however, I fully realize the headwinds Jeff Bezos faces. As I noted in a recent article on TheStreet, he must be getting sick and tired of having his approach of hyper-spending to fuel massive long-term opportunity second-guessed. He's only been right for more than a decade.

Nonetheless, the stock could get hit. I'm not about to take a flyer by going long an out-of-the-money put, particularly one that expires in May or June. That's partially because I am bullish, but even as a trade I cannot get with that. I elaborate on how to play bearishness when I round out this article looking at prospective Netflix trades.

Because I want to be long AMZN, I would entertain doing one of two things. Using Friday's closing prices, I could sell an AMZN May $185 put and collect about $6.30 worth of income. That protects me all the way down to $178.70. If AMZN implodes post-earnings and drops below $185, there's no need to get hysterical. While you could get put shares at $185 prior to expiration, chances are you will not. In most cases, particularly with a stock like AMZN, you will get assigned if the underlying trades below the put's strike price at expiration. But, for the record, just know that you could, theoretically, get put shares at any time.

I like the $185 put because if AMZN does plunge initially, I think it will do what it has a history of doing -- coming back strong in the weeks after earnings. If I do not get put shares, no big deal, as I generated some nice income in exchange for tying up some cash to secure the trade (I prefer cash-secured over naked puts).

Of course, it only makes sense to keep the $18,500 required to buy 100 shares of AMZN on hold if you have a pretty large-sized portfolio and/or cash balance to begin with.

The second way I would play AMZN bullishness into earnings is the same way I would play AAPL optimism. Use a buy-write to get long each stock, assuming two things:
  • You are long-term bullish and would be fine owning a stock ahead of unanticipated weakness;
  • You select a strike you would be fine having to sell your shares at in the event you get assigned.
  • Again, using Friday's closing prices, you could buy AMZN stock for $189.98 and, for every 100 shares you purchase, you could sell the AMZN May $200 call and take in $4.60 in premium income. It's called a buy-write because you buy the stock and sell the call in one transaction. With AAPL, you could buy the stock for $572.98 and, for every 100 shares picked up, you could sell the AAPL May $610 call and collect $15.05 in premium income.

    On the AMZN buy-write, you turn a 7.7% profit if you get your shares called away. On the AAPL trade, your profit, on assignment, comes out to 9.1%. If your shares do not get called away, you're long the stock, at whatever market price it trades at, and wealthier by the amount of income generated from the call sale.

    Netflix

    I am bearish NFLX and I do not own shares, therefore I would not entertain a covered call here. At the same time, I would not do what I did last year when I profited from some deep out-of-the-money puts only to buy them back two days later. Needless to say, I am sitting on a loss that only a total and complete implosion in response to Netflix's Monday earnings report could offset.

    Instead, if you're bearish, put time and intrinsic value on your side. If NFLX does not crash this week, you still can live to fight another day if you choose not to stop yourself out of the trade. But if you go deep out of the money, particularly with a close-in expiration date, you're likely toast not only on strength, but stagnation or not enough downside. If you're correct and NFLX tanks -- be it today, tomorrow or in a few months -- you're much better off being long something like the January 2013 $130 puts at $36.20 apiece.

    Not only do you give yourself much less exposure than if you shorted the stock, but you have some intrinsic value going into the trade (the difference between the strike price and market price of the underlying). You also have time value built into the premium because long-dated options stand a better chance of staying or drifting in-the-money than near-dated ones at the same strike. You pay a heftier premium, in part, for this time.

    Simply put, if NFLX rallies, you do not die as fast a death as you do when you're out-of-the-money and near-dated. You also have more time for things to turn in your favor if you stay in the trade.

    At the time of publication, the author had no positions in any of the stocks mentioned, although positions may change at any time.

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