Why is AAPL becoming dangerous, and what to do?
The American past time used to be baseball. But the last couple years that has changed. The new American past time has become get long AAPL any way you can and wait for the profits to accumulate. Over the last 2 years, AAPL has gone from around 190 to 500, you figure the yields, staggering! Since June 20, AAPL has risen from 315 to the current level of 502, 60% in 8 months! Let me say that one more time, 60% in 8 months! So why shouldn’t it continue and why is it becoming dangerous? I’m glad you asked. Over the last 2 weeks, AAPL has shown a changed personality that you should be aware of. This personality is much different than the fun loving, get on my back , and I’ll take you up, up, to always higher stock prices. From a psychological perspective, this personality change started about 2 weeks ago around February 3. AAPL was trading at 460, and the March at-the-money implied volatility was around 19. What does that mean in English, Spanish, and Portuguese? It means everything was OK, and no real fear of the downside was propping up. But was it? The speed to the upside was really picking up. From November 25 to February 3, AAPL went from 363 to 459, 26% in a little over 2 months. Everybody wanted in! On February 10th, AAPL hit 493 and March at-the-money implied volatility in the calls spiked to 27. What’s the big deal? Option volatility usually decreases on the upside as prices go up and fear of the downside isn’t usually there. And remember, this is AAPL, this is America! But the last week, the personality disorder got much worse. As AAPL climbed a bit higher to 500, the March at-the-money option volatility climbed higher to 32 in the calls. That is an increase in 2 weeks from 19 implied volatility to 32 , an increase of 68% with the stock rising. Why are the option volatilities going up and what does it mean? First of all why are the option volatilities going up? SPEED!! Look at a pivotal day, Wednesday Feb 15, AAPL traded intra-day to 526 and closed at 497. That’s a decrease of 5% from the daily high to the close. The stocks rate of speed up and down intraday is really picking up in both directions. Sellers are coming in a bit! The last time I really saw this kind of speed to the upside was the internet debacle many years ago when stocks were screaming to the upside, do you remember what happened after they went up very fast? What does increasing option volatility mean to the retail trader? It means the green light on the stock may possibly be turning to yellow and you should exercise a bit of caution. Does this volatility news mean I can’t stay bullish on my beloved AAPL? No, it just means HOW you get long may need to change. This leads me to the strategy for today if I want to be long AAPL but be cautious!
Strategy idea: With this disturbingly changed personality in AAPL the last 2 weeks, I would approach any bullish trade very cautiously and make sure the risk/reward looks acceptable to me. In other words, if AAPL nosedives, I’m very comfortable with my total downside risk. I would initiate the below strategy after 1-2 down days.
Strategy example: Stock at 502.5 Buy 1 March 500 call and sell 1 March 505 call for a debit of around $2.40 ( $240). This strategy called a vertical debit spread, allows you to play a high priced stock for a very reasonable cost. We are actually selling an option with more time premium than we are paying for with our long. This is good considering option volatilities called implied volatility have skyrocketed the last few weeks. The risk/ reward is about 1 :1 meaning we can make $250 profit potential with maximum risk of $250. If the stock is 505 or higher at expiration ( 2 ½ dollars higher than the current 502 level), I can make 100%. This again is a cheap way with limited downside risk ( $250) to play a very expensive and volatile stock.
Be careful and have a greatweek! Dan Sheridan dan@sheridanmentoring.com
And please see our options trading for beginners page.