Trading Apple volatility

Apple: Using Technical Analysis to Trade Volatility


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.



OptionsProfits For actionable options trade ideas from a team of experts, visit TheStreet's OptionsProfits now.

My Trading Strategies

My Trading Strategies

combine stop with a trailing stop

http://www.investopedia.com/articles/trading/08/trailing-stop-loss.asp

One of the best ways to maximize the benefits of a trailing stop and a traditional stop loss is to combine them. Yes, you can use both, but it is important to note that initially the trailing stop should be deeper than your regular stop loss. An example of this concept is to have a stop loss set at 2% and the trailing stop at 2.5% so that you are able to trail a stock's price movements without getting stopped early in the game and allowing for some price fluctuation as the stock finds support and momentum. Be sure to cancel your original stop loss when the trailing stop surpasses it.

make use of margin
how?

My Market Info Strategies

trade earnings announcements:
ST price movement depends not on the actual value of the earnings but on expected/actual difference, actual vs sector benchmark, price momentum, support n resistance on chart.

EPS can be GAAP or non-GAAP and most companies announce both. Make sure when you compare estimate vs. actual, you are using either GAAP or non-GAAP on both (TOS software seems to go for non GAAP while Bloomberg does GAAP)

earnings calendar from bloomberg

What is the best source of real-time financial market news as it happens? Check out these and compare: tradethenews, eSignal's RealTimeTraders Pro Newswire

Spread between nasdaq and DOW/S&P

There seems to be a consistent spread between dow and nasdaq indices although they are correlated. How to take advantage of this spread? profit when (1) nasdaq>dow (2) nasdaq<dow or (3) as long as there is the spread.

Strategies

before mkt open, look for companies that made earnings announcements after last close.
a. place a limit BUY order on option with a large LIMIT if you think the underlyer is hot (is there a better one, maybe traillimit or trailstop on BUY?). Can do before the mkt opens.
b. after the BUY goes thru, immediately place a trailingstop (or combine it with a stop).

professional traders sometimes sell shares just before earnings announcements (they made money already and don't want to be exposed to volatility caused after earnings announcement) which can cause momentary price drop. can we take advantage of this?

many companies announce earnings and other financial data during off market hours so there could be a good opportunity to trade during premarket 8-9:30 or after hours 4-6:30. however, only stocks are allowed. what's a strategy here whereby you take advantage of earnings news and buy/sell stocks, at the same time enter options orders to kick in when mkt opens?

many websites and trading apps (like TOS) show earning calendars but how to search on the blue chip companies only? you may have to do this manually i.e. create a list of blue chip companies with announcement dates. know that companies are not required to honor their announcement dates. right after the announcement, i think you can make money by taking an appropriate position (call or put) and putting in another trailstop immediately.

pre-market and after hours trading
look at TOS Times and Sales under "gadgets" to see what prices stocks are trading on various ecns after hours or before mkt open. may be able to assess buy/sell pressures from this info and create appropriate trades right when mkt opens. sam: my idea is that only the pros trade in off hours and mkt open usually follows the price movement in the off hours.

NASDAQ-100 Pre-Market Heatmap

adopt contrarian techniques
http://biz.yahoo.com/etfguide/090417/241_id.html?.&.pf=retirement


My Options Strategies

small but sure intra-day profit on OEX

Look at where the market is going. When you detect a turnaround, quickly take that position and buy (call or put, depending on what direction the turnaround is occurring). Wait to see if your hunch was right.
(A) If Y, do 2 things. (1) set an alert for floor (so that u might wanna sell and mimimize loss) and (2) set an alert for ceiling (so that u can go back and comfortably make a trailstop order). Alternatively, without the alert, you can create an actual stop loss order for (1). Alert(1) gives you the last-minute choice to hold off on selling if you think your position is going to turn around, but don't wait too long. If it is not turning around, your hunch was not right so make another trade outlined in (B).
(B) If N (you hunch was not right), do 2 things. (1) create another order in the direction the market is moving against your original hunch i.e. buy call or put, opposite to your first order. [Don't be so concerned about this second trade because it is almost impossible to lose money on both trades since they are opposite and you will be close to break-even at the worst.] (2) Monitor both of your positions. You are relatively safe. Your piority now should be to minimize loss and to even make some profit but that may not occur intra-day, especially if the market is only moving sideways. So at this point, when you have 2 opposite positions, you want to extend your closing out to another day ot two, whenever the market moves drastically (and they have been generally speaking, especially when it opens). The only caveat is that, if you are only 1 or 2 days away from expiration, the time value decays much faster so the market has to move that much more drastically to break even with 2 positions over 2/3 days. When one trade moves enough that, if you were to close out BOTH positions you would break even, (1) close out the trade that is of a lower value (the one currently moving against market) and (2) immediately create a stop loss or trail stop on the other.

Hopefully you will make profit with (A). If not, at worst, you will break even with (A) and (B). Example, I bot OEX 395 may call (month away from exp) at $14.2 sometime after 10AM when the market was turning around from negative open to when it was just hitting the positive side. I then set a floor alert at BID=$13.9 (looking back this should have been $13.4 to confidently assert the market was moving against me but oh well i lucked out here) and ceiling alert at BID=$15.2. I then got the ceiling alert (whoa lucky me!) after a few minutes (asserting my hunch of turnaround was right) at which point I created a trailstop at -.30 (meaning MKT-.30 most probably with TOS since they don't give you the option to specify MKT-.30, BID-.30 or ASK-.30) when BID=$15.2 and ASK=$15.60 or something (ignore the LAST which was still at $14.2). This tells me MKT was somewhere between $15.2 - $15.6. Anyways the trailstop got triggered and the position was sold at $15.50.

I was comfortable enough to shell out $1300 to $1600 for this one contract and to make about $100-$150 profit like this. I do think this strategy is relatively safe. I should aim to make $500 intra-day profit by either (1) shelling out $5000-$6000 i.e buy 5 contracts or (2) run this strategy multiple times a day (especially when you can afford to watch market turn around on a big piece of news).

I also think this strategy is better than trading a spread because with spread, you are essentially trading both (A) and (B) simultaneously while saving on commission. With this strategy, on the upside, you could potentially make a lot more gain with (A) without (B), while on the downside, you pay an extra commission to take the same position as the spread. I think that extra commission, being the cost of this strategy over the spread strategy, is well worth it.

when to place the 1st (A) trade? (1) right at mkt open - if the previous close was really up or down, then assume mkt open is turning around (2) after mkt open - give 15 mins or so whenever mkt begins to take a turn (may or may not happen though) (3) near the mkt close - if the mkt is moderately higher/lower to much higher/lower, assume the next morning's open will turn around so make the trade at/near mkt close in the opposite direction (4) when a piece of news during mkt seems to break the market trend - usually happens fast, make the trade right away.

On DJX (1/100 of DJIA)

Applies to any any index option: wait until u see a trend (not at the bell or before, give some time to settle). jump in and set a stop. hopefully stop won't trigger. assuming so, create a new TS order with a fairly wide gap (where if stop does trigger on this order, be prapared for a small loss. on the upside, the wide gap shields u from small hiccups and hopefully puts you in a profitable path). then replace the TS with a new one as time goes by, locking in some profit. ** if ur at almost the end of day, n u find that makrket is moving against u, don't make the trail stop kick in yet i.e. make the gap even wider if u can (as long as u can take that extra loss in the worst case scenario). the idea is that, hopefully stop does not trigger and the order remains active at the next open. that's when u may see market swinging back in ur favor (on average, if mkt goes up big on a day, next day it sheds some and vice-versa) or at the worst case, u will lose that extra money u r ok with loosing.