Options Corner: Wall Street's Risk Modeling Nightmare Creates Massive Opportunities In Amazon Put Spreads

It's a terrifying time to be a market maker these days. Recently, the University of Michigan's Consumer Sentiment Index for April plunged to 50.4, its lowest reading since June 2022. It also represents a steep drop from March's reading of 57 points. Worrying investors is that the figure missed economists' forecast of 54.5 by a significant margin. Naturally, this news item carries significant — and negative — implications for Amazon.com Inc AMZN.

Adding to the dour environment is the discouraging context behind the velocity decline. “Consumer sentiment fell for the fourth straight month, plunging 11% from March,” said Joanne Hsu, director of the Survey of Consumers at the University of Michigan. “This decline was, like last month’s, pervasive and unanimous across age, income, education, geographic region and political affiliation.”

Hsu told Bloomberg TV that the deteriorating economic outlook cut across the political spectrum for two months. At the same time, inflation expectations are rising, for both the short and long term. Subsequently, the projection of fading consumer sentiment does little to bolster confidence in Amazon.

Nevertheless, market makers cannot just hedge for a potential downturn. As investors saw during the midweek session's remarkable turnaround following President Donald Trump's 90-day pause on tariffs for select countries, anything can happen under the current administration.

Plus, it's worth pointing out that, as of this writing, Amazon’s stock is down about 17% on a year-to-date basis. Those providing liquidity for derivative contracts must also hedge for the possibility of discount buying. Again, it's a terrifying time to be a market maker.

Mispriced Amazon Stock Options A Bright Spot For Speculators?

As the saying goes, one person's trash is another person's treasure. When it comes to Amazon options, the market makers' dreadful duties to provide liquidity in this equities cycle can open doors for opportunistic speculators waiting to pounce on a mistake. And there just might be one in favor of the risk-taker.

Under ordinary circumstances, pessimistic traders might buy a multi-leg options strategy known as the bear put spread. These vertical spreads — so called because the strike-price difference between the underlying long and short legs is stacked vertically (and thus for the same expiration date) — are net debit-based transactions. Simply stated, the trader pays a debit to speculate that a specific event will materialize (i.e. the target stock will fall).

On the other end of a buyer of a vertical spread is, of course, the spread's seller. Selling a credit spread represents a net credit-based transaction. Specifically, the position starts from a cash influx position. The seller receives the premium that the debit buyer pays, gambling that the clock will run out on the buyer before the debit trade becomes profitable.

For the seller, the premium received — that is, the amount of the cash influx — can be viewed as the safety margin or "credit margin." Essentially, it's the amount that the trade can move against the seller and still be profitable. Once the margin is exceeded, though, the debit buyer is now in the money. Under this scenario, the rising deficit to the margin reflects the liability of a blown-up credit spread.

What makes certain Amazon stock put spreads so compelling at this hour is that the aforementioned credit margin is on the debit side; that is, time decay (theta) favors the buyer. When risk modeling goes haywire in an attempt to accommodate all circumstances, unusual pricing dynamics may materialize. This may be what's happening right now with Amazon put options.

Getting Spotted Free Odds

Speculators looking to profit from the price modeling chaos may consider the bear put spreads expiring April 17 with a short leg strike price of $185. Specifically, the 190/185 bear spread looks enticing for speculators. This transaction involves buying the $190 put (at a time-of-writing ask of $935) and simultaneously selling the $185 put (at a bid of $625).

Subsequently, the proceeds from the short put partially offset the debit paid for the long put, resulting in a net debit paid of $310. Should Amazon fall to or below the short strike price of $185 at expiration, the trader collects the maximum reward of $190, representing a payout of over 61%.

Amazon shares in the open market were trading at a lower price than the short strike target. In other words, the trade is already in the money for the debit buyer on paper. Once time passes and if the situation stays as is, the risk taker wins.

What makes Amazon so compelling as a play on pricing mismatches is the relatively low beta of 1.39. This is not a security that will statistically react too strongly in either direction.

Speaking of statistics, the chances that on any given week Amazon would rise is around 53% to 54%. That’s not much of an advantage for bulls. However, market makers could be hedging for the momentum-riding tendencies of Amazon, which could be attempting to bounce back from the $170 lows. Then again, the momentum argument is also risky considering how few one-week returns exceeding 10% there have been, resulting in data distortion.

The thing to remember is that as the above bear put spread stands, the wager isn't necessarily that the stock will fall (because it's already below the profitability threshold for bears on paper).

Rather, it's that Amazon won't materially rise from here.

In that context, the above put spread appears mispriced in favor of the debit buyer.

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