How to benefit from a Trade you didn't take.
Yesterday, the trade suggested in AAPL was never executed. Despite AAPL falling into our buy territory (below 591), deeply in fact, down to just below 588, it was never possible to place the trade at our limit of 2.50 or less. AAPL stage a tremendous reversal from that support level, taking back all of its losses and closing down fractionally. So why did it not execute? AAPL dropped over 16 points, theoretically an out of the money butterfly (which it was as AAPL fell through 595) should drop in value as price gets further away from its strikes. The answer lies in the volatility increase that AAPL and most stocks see as price dropped quickly. AAPL's was magnified by its earnings announcement due after the close tonight. The increase in volatility (vol as it is known as on the floors) makes out of the money options more valuable as the likelihood of those strikes being in the money increases. Conversely as price rises, vol usually falls, though not always. Because of yesterdays sharp drop, vol in the entire market increased rather dramatically.VIX rose yesterday from 16.30 to 20.50 at its high, a rise of over 30%. Fear was very prevalent, and it showed in increased option prices.
So what can we learn from this. Well, it is important to observe what happened on the ensuing rally. Suppose a trader decided to execute the trade anyway, he was bullish and wanted to get on board. Without legging the spread a price of $3.00 probably could have been paid. From there AAPL rallied back 18 points. How did the spread perform? As a low risk spread, the payoff shouldn't be expected to be great on an intraday move, even one as large as yesterday’s. The spread closed at 3.55, which would have been close to a 20% profit, nothing to sneeze at but still the buyer probably would have been disappointed. This is why a limit on the purchase was suggested. At times of high vol, it is imperative to play close to the vest and not get caught up in the frenzy. This butterfly still has an excellent chance of being very profitable at expo, but the risk reward was diminished by paying up for it. There surely were other trades that could have made huge profits yesterday, but they entailed more risk at a time when initiating risk could be very painful. Puts could have been sold, put spreads also, out of the money buy writes or even straight long stock or calls would have worked. But..... As day trades?.....Yes. Swing trades?....Maybe. Recommended trades to an audience of varied backgrounds and experience? .......Not a chance. So, as the barber says.... NEXT!