In Amazon vs. eBay, Traders Might Win
When heavyweight companies fight, one thing is clear – there is a lot of money at stake. That’s true no matter which companies are fighting. So, there is no reason to believe the recent beginning of a duel between Amazon and eBay is about anything other than money.
The Fight Seems Obscure
Yahoo Finance reported that EBay (Nasdaq: EBAY) claims online retail giant Amazon (Nasdaq: AMZN) deployed an illegal scheme to recruit eBay’s “high-value” sellers to Amazon, in a California lawsuit filed recently in a Silicon Valley court.
The lawsuit alleges Amazon representatives made fraudulent contact with eBay sellers, in the U.S. and overseas, through eBay’s proprietary member-to-member messaging system M2M.
According to the complaint, eBay claims Amazon representatives set up eBay member accounts with intent to circumvent eBay’s message monitoring systems, using unconventional formats for email addresses and phone numbers.
“[Amazon representatives] changed the presentation of Amazon email addresses, for example…jdoe AT amazon DOT com. They also provided unconventional phone number formats solely for the purpose of evading detection — telling eBay sellers, for example, ‘you can write down 2.0.6. — 5.5.5. — 22.214.171.124. and then delete this message if you so choose.’”
EBay claims some of the Amazon representatives who made contact with eBay sellers referred to themselves as “hunter/recruiters.”
The messaging system allows eBay’s buyers and sellers to communicate electronically, though the company’s User Agreement policy prohibits the parties from using the system to offer, reference, or request contact information. It further prohibits buyers and sellers from contact concerning buying or selling outside of eBay.
Offers to buy or sell outside of its platform, eBay says, present risk of fraud, and can signal an attempt to avoid eBay fees.
Amazon’s user policies are similar, and require those who establish Amazon accounts to follow its rules.
“Any attempt to circumvent the established Amazon sales process or to divert Amazon users to another website or sales process is prohibited,” its policy states.
EBay, in its five-count complaint, alleges that Amazon intentionally interfered with eBay’s contractual and economic relations, perpetuated fraudulent activity on the company, and violated California’s Penal Code and Business and Professions Code. The online marketplace says that two weeks before filing the lawsuit it sent Amazon a cease and desist letter.
The company is asking for a jury trial and demanding a stop to the allegedly fraudulent activity, along with monetary and punitive damages.
The Problem for eBay Is An Opportunity for Traders
eBay has been in a short term down trend as the chart below shows.
The longer term trend in eBay is also down.
This means traders can benefit from the news by placing a trade that could benefit from a continuation of the trends seen in the charts.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
A Bear Call Spread in EBAY
For EBAY, we could sell a November 16 $28 call for about $1.60 and buy a November 16 $33 call for about $0.17. This trade generates a credit of $1.43, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $143. The credit received when the trade is opened, $143 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $357. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($143).
This trade offers a potential return of about 40% of the amount risked for a holding period that is about five weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if EBAY is below $28 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $357 for this trade in EBAY.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.