With the equity markets reaching all-time highs on the back of a tech-led A.I. rally, it’s hard not to draw parallels to the dotcom bubble and bust. On Wednesday, we started to see a little bit of the air taken out of today’s bubble. We’ll present a trade that wins if one of today’s leading tech giants can’t quite live up to the bubble hype. While almost all of today’s tech and semiconductor companies generate significant revenue and profits — unlike the shells of the dot-com boom — the tech sector’s performance has many parallels to the late 90’s. Additionally, as valuations continue to outpace revenue and EPS growth, the market seems to have reached a breaking point with Microsoft, AMD and Alphabet earnings. The negative reaction to those earnings suggests that investors are no longer accepting valuations that are clearly well ahead of actual corporate earnings growth. In my opinion, while this AI revolution is well on its way, we are still in the early days of a disruptive technology. In the short run, there are opportunities to seek downside exposure during these times of excess, and as valuations pullback towards more realistic levels, it will ultimately provide a better buying opportunity for the long run. Amazon looks stretched Looking at the short run, earnings for Amazon (AMZN) are on deck after the close on Thursday and at risk of a pullback with the rest of tech. While AMZN is technically under the consumer discretionary sector, a large part of its valuation is derived from its cloud services business. As we look at AMZN’s stock surge over the past year, it’s starting to look stretched to the upside and showing signs of exhaustion. We’ve seen high prices that are no longer coupled with momentum. Additionally, the relative performance of AMZN to the tech sector has no longer made new highs along with the absolute chart, suggesting distribution of the stock going into earnings. This increases the probability of a pullback rather than breakout on earnings this week. The valuation of AMZN is another concerning factor, trading at 43 times forward earnings and more than a 100% premium to the market and its peers. While a premium valuation is expected with a 35% EPS growth that is expected for 2024, my concern is that there is a lot of room on the downside. Especially if we consider how the market has reacted to UPS and Microsoft’s earning, which respectively provide a preview into AMZN’s eCommerce and Cloud businesses. The trade Since implied volatility on AMZN is incredibly high going into earnings, my preference is to utilize a trade structure that takes advantage of selling options premium with a call credit spread. I’m going out to March and selling the $160/$175 call vertical at a $5.24 credit. This involves: Selling the March $160 calls @ $7.80 credit Buying the March $175 calls @ $2.56 debit This trade structure will realize a max profit of $524 if AMZN is below $160 and a max loss of $976 if AMZN is above $175 per contract at expiration. This strategy has a higher probability of profit of 64% and a breakeven price of $165.24. DISCLOSURES: (None) THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
