Tuesday, June 5, 2012

Pairing up, Options Style

Yesterday as the markets made lows not seen since the beginning of the year, one stock seemed to stand out for me. And perhaps fortunately for the market it is the most important stock in the world. AAPL.  I know, I know, right now TLT is more important, VIX is more important, FXE, hell maybe even GLD. But I said stock. And yes I believe AAPL is still the most important stock despite its fall this spring. And one of the reasons, aside from its market cap is that it seems to have stopped falling. At the very least it’s relative strength vis-a-vis the market & other leaders is well impressive. If AAPL is ready to begin to reassert itself as a leader then that would be very helpful to the market as a whole. So let’s take a look at a comparison chart of the SPY (orange), PCLN (cyan), & AAPL (green of course).

They all moved pretty much in lock step until late May when they began to diverge a bit. Now I know it’s not a huge difference, and 2 weeks is of outperformance can certainly be erased very quickly, but I think its notable enough to warrant a closer look. I went into some potential turning points for SPY yesterday using fibs,  I won't rehash that, they can be found here.  http://thetradersjacket.blogspot.com/2012/06/hows-it-look_04.html  Let’s take a look at AAPL. AAPL had a nasty selloff from its highs. A potential support area was noted as 526.36, the high of a previous peak that had led to a 40 point reversal in 6 trading hours. Price held slightly above there at 528.66 on 5/18, stopping almost exactly at the 100 day MA (blue line). It then rallied to 581.50, since then while the market has made significant new lows AAPL has only dropped to yesterdays low at 548.50, well above its previos pivot low. This fits nicely with its .618 retrace of the recent rallyt 548.84, and it held above its still rising 100day MA. AAPL’s downtrend line from the highs has been broken and it has the look of a right shoulder of an inverted head & shoulders pattern forming, though its neckline is a bit slanted
. There is a case to be made that AAPL’s bottom or a bottom is in, though certainly not strong enough to bet the farm. If so, and it is a big if, a rally, possibly into earnings could certainly head back to above 600.

Now let’s take a look at another leader of the winter rally PCLN.PCLN rallied from its October lows around 411 to its highs on 410 at 775. Since then it has fallen making new lows just yesterday at 603.49. A print at 597.00 would fill a gap from February. It looks, feels like there may be more to come. The 550 area peaked the stock on 6 occasions from July thru November of last year, and 550.18 is the .618 retrace of the rally from 411 to 775. That area looks interesting.

So how can we construct a trade that could take advantage of a move on either of these two stocks that makes sense and has limited risk. We could just Buy AAPL & short PCLN, way too risky. We could buy calls on AAPL & puts on PCLN, but decay would be significant. Usin spread can allow for profitability while significantly reducing risk. I want a trade that I can put on and not babysit as I trade during the day. There are multiple spreads possible so I’ll detail the ones I chose.
I bought butterflies on both stocks to give me a risk reward that will allow me to be right on one and make more than enough to offset any loss on the other, recognizing that profitability in one may well mean a loss in the other unless they diverge. I bought the AAPL 600/620/640 call fly, average price was 1.73 and the PCLN 530/550/570 put fly, average price was 1.29. In buying a butterfly one each of the highest and lowest strikes are purchased and two of the middle strikes are sold short. So the positions look like this:

Jul 600
Jul 530
Jul 629
Jul 550
Jul 640

Per Butterfly purchased:
At July expiration
Profitable above 601.73 and below 638.27
Maximum loss        $173 per Fly
Maximum Profit    $1827 per fly with AAPL at 620
Risk Reward            10.5 - 1
At July expiration
Profitable above 531.29 and below 568.71
Maximum loss        $129 per Fly
Maximum Profit    $1871 per fly with PCLN at 550
Risk Reward            14.5 - 1
In short I want AAPL to go to 620 and PCLN to 550, though anywhere near on either will mean a profit on the whole thing. Should either spread double prior to expo I intend to sell 1/2 of the position.
PS I purchased slightly more of the AAPL flys than PCLN as I duped an order. I will keep the extras on

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