Thursday, April 18, 2013

AAPL Short Risk Reversal

UPDATE -- APR 23

AAPL reported its numbers.  After hours the stock spiked but has since returned to essentially flat.  Indications are that the numbers a neutral to slightly bullish, but I would wager that a floor has been put, expectations lowered to such a degree.

We will see on the open tomorrow how the stock reacts - volume will be important as will the range.

I will be watching the spreads on the short risk reversal for an opportunity for adjustments.  Stay tuned.

After hours trading 403 - 430

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UPDATE -- APR 22

It is the day before AAPL announces earning and the stock rallies $8.14 and hitting a high of $402.  It closes at $398 and change.

The current value of the position is -41 / contract.

We will see how the market reacts after tomorrow's numbers.  Remember we are looking to adjust to reduce risk and lock in gains.

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APR 18 - TRADE OPENED

AAPL declined strongly (again!) this week into the $405-$400 range, dropping $23 one day alone.  Volatility expanded greatly in the week before earnings.

A couple of our butterflys positions moved out of the profitable range to the downside and had to be closed for a loss closed for a loss on the weeklies as time is running out.

Fundamentally, there are a couple of things of note, AAPL has been in a precipitous decline since the highs of $700 back in the fall.  The P/E ratio for this very profitable company is now under 9.  The market seems to have factored in catastrophic fundamental shifts for the company.  Nearly half the market value of the company is now just cash.  Assumption is that business is strong and we are now seeing panic selling driving the price.

It would appear that we are now closer to the bottom.  With that, we are selling a risk-reversal (a synthetic long stock position).  We are selling the put spread below the market and buying the call spread with the proceeds of that sale above the market.

The components of the trade are as follows:

Sell Jun 2013 Put Spread (375-370)
Buy Jun 2013 Call Spread (420-425)

for almost even money, a 0.03 Debit.

The 375-370 put spread is the lower range of a weekly demand zone.

The stock is 28 points from the downside and about 15 points from the upside.

Here's how the structure works (along with intended adjustments)

The structure technically flat from 375 to 420 at June expiration, but the Greeks show a bullish profile (+ delta), meaning the position will make money going up, loose money going down with respect to stock price.

The Put Spread was sold for 1.63 Credit
The Call Spread was purchased for 1.66 Debit

The trade structure is on for a net 0.03 Debit (almost even money)

The maximum risk on the trade is on the Put Spread side (5-1.63-0.03 = 3.40)

Adjustments

We want to make up the 3.37 in risk by doing a couple of things:

1) STOCK FALLS - Our call spread and put spread will loose value, to a maximum of 3.37 on the put spread side.  This is not ideal, but we have time.  We could sell some shorter term weekly OTM call spreads to help cover the loss.

2) STOCK RISES - Both positions will make money.  The best adjustment here is to lock in profits by

a) selling half the position at a profit (remember we are looking to recover as much of the 3.37 risk)

b) buy a higher strike put spread (like 390-385) for no more than 1.63-1.60 (this guarantees that the 3.37 risk on the initial put spread would be covered)

The wider the apart the two short put strikes are the better the structure.  The gap is the profit part of the structure at expiration should the stock fall into it.

c) Sell a call spread above the first one for at least 1.66 credit.  This covers off the debit on the first call spread.

The wider the apart the two short calls the bigger the target for profit potential at expiration.


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