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Why I'm Shorting Amazon Today

Tuesday, August 26, 2014 7:30 AM

Amazon.com (Nasdaq: AMZN) has been one of Wall Street's darlings for some time. From its 2008 lows to its early 2014 highs, the company has seen a meteoric 1,000% rise in its stock price and has expanded its product lineup and reach to become the largest online retailer in the world.

This is certainly impressive and may not seem like a company you should be bearish on, but that 1,000% gain wasn't a straight uphill shot. It was fraught with corrections of 10%, 20%, even 30% and more, and I believe we are on the precipice of another.

Amazon fired off a slew of new products this year, including tablets, a set-top box and its first smartphone, with mediocre success. And on Thursday, I had the pleasure of briefly discussing Amazon's drones on Fox Business. While drones delivering goods to your doorstep within 30 minutes of purchase is a nifty idea, and Amazon has hired NASA engineers and researchers to further the project, it adds little near-term value to the company. And it's certainly no reason to pay almost 500 times earnings for AMZN.

Let me say now that I believe the company's long-term potential is tremendous. I just don't like the stock right now at these prices -- and one of my main reasons is actually something I love about Amazon.

I am an Amazon Prime member and I couldn't be happier with the service. But I am baffled at how the company actually makes money at $99 per year for free two-day shipping on just about everything it sells.

In the past week, I had four packages overnighted to me at no charge. Amazon often has to overnight orders placed late in the day to keep its two-day guarantee. Two of the packages I received were large boxes containing cheap bicycle tires that Amazon might make a $10 profit on -- on a very good day. This is just one of dozens of "net negative" profits I personally encounter with Amazon on a monthly basis.

Being a statistics guy, I wanted to did deeper and get specifics. I used my UPS account to simulate the shipping costs Amazon might pay for each bike tire using the overnight saver rate. I was shocked when I saw $245.11 per box! I'm sure Amazon has a comprehensive and incredibly cheap deal with UPS and other carriers, but how much can the company really save? Even if it costs $12 to overnight these boxes, that's still a net loser for Amazon.

I then ran some hypothetical P&L calculations using all sorts of inputs, margins, shipping costs, etc. My calculations were very conservative, favoring Amazon and using the company's pubic data. Almost every scenario I came up with showed Amazon as a net loser on Prime, and I didn't even account for returns or other slippage. Perhaps this explains the negative profit margins.

On July 24, Amazon reported another big earnings miss, posting a loss of $0.27 per share compared with estimates for a loss of $0.15. Genius CEO Jeff Bezos has been given more leeway than Steve Jobs could ever garner from Wall Street when it comes to earnings growth, but one must begin to really question Amazon's near-term trajectory.

The bottom line is that Amazon's multiples and outlook are simply too rosy with not enough hard data to support them. Not only that, but the stock's chart has been breaking down.

AMZN Stock Chart

Investors bid shares up above their 200-day moving average ahead of last month's earnings report. Since disappointing, AMZN not only failed to fill in that earnings gap, but it is struggling with a light resistance level at $336, even as the broader market rallies.

Above that, the 200-day at around $348 and the $362 pre-earnings high will be large hurdles. Coincidentally, two of these three points overlap with major Fibonacci levels, adding more strength to their resistance. Stocastics are also showing a fresh bearish cross (trend beginning).

I'm expecting AMZN to fall to the next Fibonacci level at $312.80.

AMZN Put Option Trade

Today, I am interested in buying AMZN Oct 355 Puts for a limit price of $26.50.

AMZN Put Option

This put option has a delta of 77, which means it will move roughly $0.77 for every dollar that AMZN moves, but it costs only a fraction the price of the stock.

The trade breaks even on expiration at $328.50 ($355 strike price minus $26.50 options premium), which is 1% below current prices.

Our downside profit target for AMZN will be $313, at which point our put option will be worth at least $42. But because AMZN can be volatile and is still a popular stock with the bulls, we are going to be conservative and set our profit target at $40.

Once you enter the trade, place a good 'til canceled (GTC) order to sell at $40 so you don't forget.

Recommended Trade Setup:

-- Buy AMZN Oct 355 Puts at $26.50 or less (use limit orders)
-- Set stop-loss at $14
-- Set price target at $40 for a potential 51% gain in two months

P.S.-- It's easy to expect long-term growth for a company as successful as Amazon, but it's important - and profitable - to trade based on the hard data. That is the same approach my colleague Amber Hestla has taken in her premium newsletter, Income Trader. Since the inaugural issue, every single trade she's closed has been a winner. On average, her trades generate 7.4% in "Instant Income" every 56 days, or 48.2% a year. Learn exactly how you can make the same winning trades here.

This article originally appeared on ProfitableTrader.com: Why I'm Shorting Amazon Today​

Jared Levy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.