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AAPL Trade

July 20, 2008
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Here is a recap and update on the AAPL trade I present in group the day I initiated it.

Here is the long term monthly chart of AAPL since its major run began.

After a heavy drop half a year ago, we’ve put in a monthly equal high. Is the trend ending?

(Click image to see it bigger.)

The weekly chart shows the fast drop on heavy volume as the bull trend of high highs and higher lows was ended in January after the late December attempt to move above the recent resistence had quickly failed and the stock broke down to lower lows. After finding support at 120 the stock rallied on somewhat weaker volume only to fail at the old resistance, further establishing that 190 area.

A flag has formed with support in the short term at around 165. Until the range between 165 and 190 is broken, we should expect consolidation and a rebalancing of buyers and sellers. Which ever direction the line is broken is likely to be the direction of further movement with an initial likely move of 25 pts. judging from the height of this range. To the downside, support beyond that is likely a touch lower at 130 to 120.

I initiated this position on June 12 when the stock moved below the closing low between the small double top structure.

6/12 Long Oct 170 $17.30 debt

I wanted to give the downside the benefit of the doubt and leave a few days of downward movement before selling a shorter term put to create a diagonal spread and counteract the drastic affects of time decay on this option. (This is known as “Legging in” to a spread. It can have great rewards, but is also quite dicey and can make things a lot less pleasant when things don’t work out as hoped.) Originally, I wanted to sell the 160 put, but I missed the first opportunity and after waiting for a resumption of weakness, time decay had already had enough affect on the options chain that the 160 did not offer enough premium for my liking. June 20 was the day I legged into the diagonal.

6/20 Short July 165 put for $4.15 credit

The waiting game began, my least favorite part of trading spreads or any kind of options selling strategy. Time MUST pass for it to do its work. The stock tested resistance, but didn’t move through it.

Going into July expiration I was looking for the right time to roll the short side into August. I took a chance, buying back the short on July 16 hoping for a drop in the next day or two to sell August at a more favorable price than if I had just rolled it in one trade. Friday, the 18th, things went my way and I sold the August 165 put.

7/16 Buy to cover July 165 put $1.01 Debit

7/18 Short Aug 165 put $9.30 Credit

Total Debit to date=$4.86

Current mark price on the open position: $7.3

There are two months left for rolling the short side for further credit. Judging from friday’s values with the stock just above 165, the roll value for the 165 July/August (buying July/selling August, or in options terminology, selling that Calendar spread), would be approximately a credit of $8 or so if the stock is ATM (At the money, in this case 165).

The waiting game continues. 165 support and the 200 MA will be important levels to watch for a breakdown or bounce. We can also see a potential descending triangle in the making. However, I will focus the now established sideways range with equal highs and lows because that is way IS and the triangle is what MAY be. Until 181.50 is meaningfully broken, I will remain comfortable with the position allowing for time decay and potentially a nice roll to Sep. with the short put. The ideal spot for that would be with the stock right at the strike price, inflating it with the highest potential time premium while the current month continues to deflate more rapidly.

Earnings come out tomorrow, monday, and it may well be a sizable jump in either direction. The Aug. 165 straddle shows a theoretical price of $20.41, which can serve as a proxy for the market’s expectation of the distance the stock will move in either direction in reaction to the news.

Here is the position as it shows on the Analyze page, not including the credit of $3.14 from the short July 165. Though I might put together the predicted move of the straddle price with the outter edges of this P/L picture and think that it’s not a great looking scenario, I will stick to the charts for the final say. In this case, my downward biased reading is unchanged and if it does move in that direction by a little or a lot, it will provide me with further opportunities to roll, cover the short put and ride the move down with the long put, or just take my profit off the table.

To the upside, if and when 190 is broken, all bets are off for the bear argument. Until that time, and as long as theta is still working in my favor, I will most likely stick with the trade. My decisions will also be influenced by the action of the broad markets and the relative strength or weakness of this stock. At Aug expiration, the 190 area is about my break even point on the trade to date including the credit not shown in the analyze page from the July put.

Though I love the logic of marrying the advantages of technical analysis with the unquestionable logic of using options selling and time decay to your favor, I still don’t know quite what to make of this type of trading over the long run. There is a tremendous amount of subjectivity involved with each decision to take action. So while the time decay does wonders for allowing for error, there is also plenty of potential for error.

I do like the ability to use options leverage and time decay to my advantage and also stay more toward an intermediate time frame instead of in and out trading short term. And I do like tendency for this type of position to avoid max loss when managed well while still allowing potential for very high percentage returns per position. But this is truly discretionary trading on so many levels to the degree that it seems almost inevitable to have more hidden land mines than a more simple strategy. I guess it just takes time to warm up to one’s particular “style,” particularly when dealing with more complicated approaches.

Please feel free to chime in any thoughts.

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