Shorting Out-of-the-Money Amazon Puts Generates Attractive One-Month Yields

Amazon Inc. (AMZN) stock has been flat for more than a month. It makes sense to take advantage of this by selling short out-of-the-money (OTM) AMZN puts and picking up attractive yields. This article will show how to make a 1.8% yield by selling short AMZN puts at a 5% lower strike price.

AMZN is at $210.28 in midday trading on Monday, March 23. This is where it was in early February, but well below its 3-month peak of $247.38 on January 9.

I discussed shorting $195 and $200 puts (at-the-money and in-the-money strike prices) expiring March 20 in a Feb. 16 Barchart article, “Amazon Put Options at Lower Strike Prices Have High Yields.”

This provided short-put yields of between 3.1% to 4.2%. You could have also sold short the $200 put and bought the $195 put for a net 1.125% one-month yield.

That play worked out well as AMZN closed above these high-yield put strike prices on March 20 (i.e., $205.37). The puts expired worthless, and the investors kept all the income.

It makes sense now to sell short these same strike prices, which are now out-of-the-money for a one-month high-yield play.

For example, the April 24 expiration period shows that the $200 put option has a $3.83 midpoint premium for the next month, and the $195.00 put has a $2.82 put premium.

That implies a short-seller of these out-of-the-money (OTM) puts can make the following yields:

$3.83/$200.00 = 1.915%, -5% below AMZN’s price

$2.82/$195.00 = 1.446%, -7.4% lower

Note that the puts have low delta ratios – between 21% and 27%. That implies there is only about a quarter probability that AMZN will fall to the average of these two strike prices on or before April 24. This provides some downside protection, in the sense that past variability predicts future performance.

Nevertheless, even if this occurs, the investor has a lower breakeven point, given the income already received:

$197.50 (avg strike) – $3.33 (avg income) = $194.17 B/E

That’s 7.7% lower than today’s price. In other words, an investor who sells short these two strike price put contracts could potentially buy into AMZN at a 7.7% lower cost. They also get to keep the income received by shorting these puts.

That’s what makes selling short AMZN puts so worthwhile for value investors. For one-month expiry periods, an investor can make a 1.4% to 1.9% yield in 5% to 7.4% lower strike prices (i.e., out-of-the-money) compared to today’s spot price.

Nevertheless, if AMZN falls below $197.50, the investor could end up with an unrealized loss. One way around this is to sell short the $200 put and buy the $195.00 put. That provides a yield of 0.5% over the next month:

$3.83 – $2.82 = $1.01

$1.01 / $200 = 0.005 = 0.5% yield

But at least for any AMZN price below $195.00, the investor will have no exposure. In fact, the next breakeven will be:

$200 – $1.01 = $198.99

So, the net potential loss is just $198.99-$1.95.00, or $3.99

That works out to a potential unrealized loss of just 2.0% (i.e., $3.99/$200). This loss could be made up in the next month by shorting another 2.0% OTM put yield play, or even selling short a covered call (OTM) price.

The bottom line is that this is one way to make a good potential yield (0.5%) for one month and also potentially set a lower buy-in point into AMZN stock.

On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com