Amazon was included in the weekend Options Report for a second time in a row due to its bull breakout pattern. In discussing strategy selection for the $3,300 behemoth, I mentioned that bull call spreads were much more palatable than long calls due to AMZN’s rich price tag. I then added that you would need a massive account to justify purchasing calls outright.

In response, everyone’s favorite Jimbo asked the following:

So what constitutes a “massive” account in order to afford a long call on AMZN? is there a scale to massive? Who buys 1 share of BRK.A or even 100 shares of BRK.A? or event 100 shares of AMZN or GOOG? When is that an efficient use of capital as I guess things like Beta come into play?

Maybe another question is when does it make sense to buy 100 shares of AMZN? Is there a pro or con to this when your account size is 500K+ or when your total Net Worth is > $1M? Also, where would you do it in a taxable or tax-advantaged account?

Thoughts from a Jimbo

We can back into how large of an account you would need to justify a long call play on AMZN. Suppose we’re looking to purchase an Oct ATM call. Right now, the Oct $3,300 call costs approximately $20,000. In my experience, even with a well-placed stop loss, you typically lose between 30% to 50% of the trade cost with a long call. For this Amazon option, that would translate into a loss of $6,000 to $10,000. Let’s be generous and use the lower number.

The only traders that should be purchasing this call option on AMZN are those that are willing to risk $6,000 on a speculation trade. Suppose you’re willing to lose 1% of your account on these types of plays. That means you need a $600,000 account. The term “massive” is subjective, but I suspect most traders listening to the Options Report would consider that a hefty account size.

In contrast to the $20k required for an AMZN long call, we could build a bull call spread for only $1k to $2k.

As far as who buys 100 shares of high-priced stocks like AMZN, BRK.A, and GOOGL, it’s either a very high net worth individual, or more likely an institution (e.g., pension funds, endowment funds mutual funds, hedge funds, banks, etc…).

As far as the efficient use of capital angle, I’m not a fan of throwing a large percentage of an account into a single stock. It’s much safer to use a diversified ETF like SPY, QQQ, or the like. Remember, the stock market has turned many a prince into paupers. As unlikely as it seems that Amazon will ever not rule the world, such was said of General Electric, Exxon Mobil, and a whole host of other past giants.

Opinions vary on the appropriate percentage, but I like the rule of thumb of no more than 5%-10% in a single stock.

Taxable or Tax-Advantaged Account

For the uninitiated, a tax-advantaged account would be something like a 401(k) or IRA. The Traditional IRA grows tax-deferred (you pay tax when you take money out in retirement), and the ROTH IRA grows tax-free. There isn’t one answer appropriate to all individuals, but which account you buy the shares in comes down to a couple of factors. First off, I probably have investments in both account types simply because I have money in both accounts.

AMZN doesn’t pay a dividend, so you only pay taxes on it if you sell. That means it’s not any different than most other growth stocks. Thus, the question isn’t where would you own AMZN; it’s “where would you own stocks?” My answer is, “in any account I have capital that needs investing.”

One rule of thumb that I agree with is the preference of owning dividend-paying assets in a tax-deferred or tax-free account. That way I don’t have to worry about paying taxes on the dividends every year.

There may be other considerations I forgetting about, but those are the ones that come to mind.

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