For AMZN, Top Relative Strength Among RMO Buys

10/19/10 09:04:53 AM

by Donald W. Pendergast, Jr.

Amazon.com shares are offering a potentially bullish trade setup, one based on a proven trading system's long entry signal.

Security: AMZN
Position: Buy

Amazon.com (AMZN) shares have done pretty well since putting in a major low last summer, rising more than $58 in less than four months. Right now, the shares appear to be poised for a continuation breakout or a period of consolidation, but not for an outright decline.

FIGURE 1: AMZN, DAILY. Aggressive traders might be comfortable taking a straight long breakout entry here, while those less sure of an immediate rise might prefer to go the covered call route. Selling a $160 November call for every 100 shares of AMZN provides a good mix of premiums and staying power.

Graphic provided by: MetaStock.

For breakout traders, this trade setup says "Let's go"; money flow is supportive of further gains, the trendlines have been ramping higher, the stock has outrageously high relative strength versus the Standard & Poor's 500 (.SPX) and the recent break higher comes with a wide range, even as the Fibonacci 127% extension ratio has been exceeded. In addition, the Rahul Mohindar oscillator (RMO) trading system in MetaStock 11 has also issued a fresh RMO swing buy signal. See Figure 1.

So you can take the trade -- or not. Maybe AMZN will surge higher and you can grab another $5 or even $10 out of it without too much trouble. Or maybe it will chop around near the $150-$165 area for several weeks, deciding to further digest the massive gains made since July.

Adding to the confusion is the possibility of a cup & handle formation, one that may be about halfway formed (if at all). So instead of taking this breakout right away or waiting for a cup & handle that may never even fully form, why not just avoid discretionary trader gridlock and buy a covered call instead?

With only 31 days until November option expiration, consider selling a $160 strike call option for every 100 shares of AMZN you wish to acquire. You can sell one for about $11 ($1,100 in cash to your margin account right up front), and the sale will give you a nice cushion if AMZN decides to delay a northside breakout for a few weeks -- just carving out an extended consolidation instead.

With the stock near $163 now, that $11 in cash for the short call brings your effective breakeven price down toward $152, which also happens to be the lower range of the recent consolidation.

To give AMZN the full benefit of the doubt, why not just set an exit point on a daily close below $150 -- at which point you close out the whole trade and walk away with a minor loss. If the stock finally follows through on a break higher, give the stock plenty of room to back and fill so you don't get shaken out of the trade prematurely.

Covered call trades can be a wise choice when you're reasonably sure that a stock is destined for higher valuations, but the timing of the anticipated event is a bit more uncertain. This could be one of those times to employ such a stock/option strategy.

Donald W. Pendergast, Jr.

Donald W. Pendergast is a financial markets consultant who offers specialized services to stock brokers and high net worth individuals who seek a better bottom line for their portfolios.

Title:	Writer, market consultant
Company:	Linear Trading Systems LLC
	Jacksonville, FL 32217
Phone # for sales:	904-239-9564
E-mail address:	lineartradingsys@gmail.com
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