Apple Investors Here’s My I Have No Idea Strategies
Yup, I submit to the great Bear in the sky, because it has become painfully obvious that in this frothy market I have no idea which way the markets are headed. A rally today was all but in the bag, or so I thought, as professed in my last blog entry. But volatility kicked it up a notch today, as evidenced by the $VIX breaking out of its down channel and the markets and AAPL doing an about face after a powerful open.
The market has been pivoting between critical support and resistance on most if the indices for the past several weeks, and recently they have been consolidating to their bases. Out of these tight bases come the strongest directional moves but right now the direction is uncertain. So how do you play such a volatile market? Well, the flexibility of options allows us to construct trades that are market neutral, such a strategy can make you money regardless of the market direction.
The strategies are part of a family of techniques that are designed to play both sides of the ticker. There are three patterns that I’ll cover here that differ in their character, but all can be categorized under the general moniker of Straddle.
| Straddles | ||||
|---|---|---|---|---|
| Straddle | Strangle | Gut | ||
| Max Profit | Low | High | Mid | |
| Max Loss | High | Mid | Low | |
| Cost | Mid | Low | High | |
| Break Even | Broad | Mid | Narrow | |
The Straddle Position
This strategy profits whether the underlying stock goes up or down. The idea of a straddle is that the potential loss is much less than the potential profit. This is a multi-leg position, meaning you buy more than one contract with opposing characteristics. In the case of a simple Straddle, you buy a Put and a Call at the same strike price.
You can make money several ways with a Straddle. First if the Call option goes up in price, along with the underlying stock, and the Put option expires out of the money. Second, if the Put option goes down in price, along with the underlying stock, and the Call option expires out of the money. And third, if either the price goes up or down beyond the break even point and you close the position with a gain, before the option legs expire.
The caveat is that if the underlying stock price does not move far from the strike price before the option either expires or before you decide to close or sell the position, you will have a loss. This is the range of price between the break even points. With the way AAPL has been moving on an average day, this strategy seems to be a perfect fit.
Example
Let’s create a position using AAPL as the underlying stock, and well Straddle AAPL at a strike price of $165. That would result in a positions with the following data points. The assumption is that we’ll close the position at $170. I found the premiums by using an options calculator from iVolatility.com.
| AAPL Oct 2008 Straddle Strike $165 - Close $170 | |||||
|---|---|---|---|---|---|
| Call / Put Chain | Lower Break | Upper Break | Max Risk | Profit @ Close | Return on Risk |
| APVIM / APVUN | $163.62 | $166.38 | $138.17 | $361.83 | 262% |
Click here to download the spreadsheet I used to perform the calculation. NOTE: The commission is not figured into the calculations.
Strangle and Gut
The Strangle and Gut strategies are very similar to the simple Straddle, in that they both involve a multi-leg position where you purchase simultaneously a Put and a Call contract. I like the Strangle for large expected moves, and the Gut for quick pops. The difference in execution of the positions follows:
Strangle - you purchase an Out of The Money (OTM) Put and Call Contract
Gut - you purchase an In The Money (ITM) Put and Call Contract
Conclusion
With the way AAPL and the markets have been acting in this Bear market, it has been extremely difficult to analyze a direction with any consistency. The froth is incredible. Additionally, the price of AAPL has been extremely volatile with daily moves of $3 to $6. Using these strategies, you could easily make significant returns in just a few days regardless of which direction the stock price moves.
If you’re looking to become a better trader, and how to best navigate turbulent markets, and most importantly, how to keep the money you have, then you should check out the Wilderness Investors Group. Click here to learn more and request membership. We have a vibrant community of professional and individual traders where you will learn how to exploit the markets and master the secrets of the trade.
