Is This Amazon’s Latest Victim?
Being Amazoned is now among a company’s worst fears. It’s a relatively new concept. It involves Amazon entering a new business, or even threatening to. As Amazon’s reach grows, it seems that any business is at risk of being Amazoned.
As experts at the Harvard Business School note, “Amazon participates in so many industries that it takes a small army of researchers at HBS to track them all: retailing, cloud computing, book stores, grocery stores, digital consumer products, commercial real estate, transportation, just to name a few.”
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The most recent victims of Amazon’s expansion plans appears to be payment services companies.
Amazon Affects PayPal
CNBC reported that Amazon is offering its discounted credit card fees to retailers that adopt Amazon Pay, the company’s online payments service, according to Bloomberg.
The report said Amazon has offered the discounts to a number of smaller sellers with higher credit card fees than Amazon, which is able to negotiate a lower fee because of its massive user base and sales volume.
Amazon Pay, which has about 30 million users, lets people buy online through their Amazon accounts as an alternative to services like PayPal Holdings, Inc. (Nasdaq: PYPL). It can be offered as an option by sellers.
The impact on PayPal was immediate with the stock falling about 4% as the report was published. The news comes as PayPal is in a down trend.
News generally strengthens the trend. The chart above shows that Amazon’s announcement comes with the stock already in a down trend. PYPL has been making lower lows, a sign that the stock’s long rally is in danger.
The next chart offers a weekly view of PYPL since the stock began trading in 2015.
In this chart, the series of accelerating up trends is highlighted. The most recent up trend, which began a little more than a year ago in April 2017, was rapid. The speed of the advance was unsustainable and the break of that up trend line seems to have stopped the stock’s advance.
The next chart adds a momentum indicator, the stochastics, which is a popular tool for traders. It confirms the breakdown in the trend.
Fundamentals point to an overvalued stock. PYPL is trading with a price to earnings (P/E) ratio of more than 40 and a price to book (P/B) ratio that is more than 6 times its industry average. The price to sales (P/S) ratio is three times the industry average.
This tells us that technicals and fundamentals were already stretched and then, the news from Amazon triggered additional selling. That sell off violated important support and the stock now appears to headed towards a decline of 10% or more.
It seems unlikely that PYPL will make a strong recovery from the recent sell off.
A Trading Strategy While Awaiting Better News
To benefit from the expected weakness in the stock, an investor could buy put options. But, high prices on put options suggests an alternative trading strategy. The option premium is high because the expected volatility of the stock is high. Options that are based on selling an option can benefit from high volatility.
In this case, with a bearish outlook, a call option should be sold.
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 is important to consider is the bear call spread. This trade 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, so this strategy will always generate a credit when it is opened.
The risk profile of this trading strategy is summarized in the diagram below.
Source: The Options Industry Council
The trade has limited up side potential and limited risk. But, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade.
The maximum potential gain with this strategy 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.
A Bear Call Spread in PYPL
For PYPL, we have a number of options available. short term investment allow us to trade frequently and potentially expand our account size quickly. Short term trades also reduce risk to some degree since there is less time for a news event to surprise traders.
In this case, we could sell a May 18 $72 call for about $1.90 and buy a May 18 $73 call for about $1.40. This trade generates a credit of $0.50, which is the difference in the amount of premium for the call that is sold and the call.
Since each contract covers 100 shares, opening this position results in immediate income of $50. The credit received when the trade is opened, $0.50 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $50. The risk is found by subtracting the difference in the strike prices ($100 or $1.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($50).
This trade offers a potential return of about 100% of the amount risked for a holding period that is about three weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if PYPL is below $72 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 $50 for this trade in PYPL.
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