By Mark Sebastian - 12/16/10 - 2:53 PM EST
Tickers in this article: VZ GOOG VOD AAPL
There are thousands of traders that use options to take advantage of technical analysis in a particular stock. When a stock bounces off a support point, traders will buy calls or sell puts and vice versa for a resistance point. In my time mentoring traders at OptionPit.com I am shocked how few traders use that same technical analysis skill for option implied volatility. In fact, because volatilities tendency to revert to the mean, it almost makes more sense to use technical analysis in volatility than it does stock price. This brings me to Apple(:AAPL).
AAPL 30-day implied volatility (IV) is sitting not on 52-week lows, but five-year lows. Basically, one can buy an AAPL at-the-money straddle at the cheapest price, relative to the price of the underlying since before AAPL was trading in the triple digits. Before getting too excited about how cheap this implied volatility is, do not forget that implied volatility can be cheap for a reason. If we take a look at the realized volatility (sometimes called historical volatility) of AAPL since its last earnings announcement, one would not be impressed by its movement. Even using the more stringent high-low realized volatility (calculating the range based on the absolute high and low trade prices) AAPL volatility has been around 20%. Using traditional calculations, AAPL implied volatility is in the single digits. It is actually at a two-year low. Even with the holidays coming up, these levels are too light. As someone who follows implied volatility and realized volatility very closely, I have a hard time imagining that AAPL will continue not to move for the next 30 days. The market will want to know how many iPhones were sold over Christmas, when exactly AAPL begin selling phones for Verizon Wireless(:VZ/VOD), how Google's(:GOOG) Android doing relative to AAPL. Basically, there are a lot of questions that could send the stock in either direction.
Apple (AAPL) Volatility Two Year
Source: Livevol
The red represents 30-day implied volatility.
The gray represents 30-day realized volatility.
How does one play AAPL with implied and realized volatility this low? For starters, I would write a piece challenging Brock Lesner to a fist fight before I would write a piece suggesting traders sell any kind of option in this product. The front month is at record low volatility, February and March, which are likely to have some earnings, are not quite there, but are also inexpensive historically. For those with a directional bias, while the at-the-money implied volatility is low across the board, vertical skew in AAPL is still a little steep (most likely trying to make up for the low volatility on the 320 strike), I would consider looking at vertical spreads in which I bought the at-the-money and sold the out-of-the-money. For those that do not have a directional bias, the fund I am working with, just dipped our toe in the AAPL January 320 straddle, buying it for $19.85 (AAPL was around $321.00 at the time). With the stock $1.00 higher at ~1:15 p.m. EST, the price is more like $19.00. If this straddle falls further, I probably buy more at varying price levels.
Remember, with a straddle it is not just the price movement that matters, it is the implied volatility. For this trade to work, I need AAPL to move in one direction, preferably fast. Hopefully, this will cause an increase in demand for insurance, running up the value of my straddle. My maximum loss on this trade is going to be $16.00, or 15%. I am hoping to sell this sucker for at least $25.00, a gain of over 25%. This trade has a decent amount of decay risk and should not be entered by someone who is not aware of the risks of time decay.
Trade: With AAPL trading at $322.25, buy to open AAPL January 320 calls for $11.25 and buy to open AAPL January 320 puts for $8.70.
At the time of publication, Mark Sebastian held a position in AAPL straddles.
Mark Sebastian is COO and Director of Education for Option Pit Option Mentoring. Sebastian is a former market maker on both the Chicago Board Options Exchange and the American Stock Exchange. Along with his role directing the path of education for Option Pit, Mark is currently the director of risk for a private hedge fund. He started the popular blog Option911, which is now the Option Pit blog. Sebastian has been published nationally on Yahoo! Finance, is a featured contributor for TheStreet's OptionsProfits, SFO, OptionsZone and is the managing editor for Expiring Monthly: The Option Traders Journal. Mark has a Bachelor's in Science from Villanova University.
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