Apple (AAPL) has formed a well-defined trading range (see Retreat or Breakthrough for Apple?).
Looking at the price chart, you see AAPL hit the top of the trading range, previous resistance, on below-average volume.
You think AAPL most likely will pull back here, fall down into the middle of the trading range or further. But this is America's favorite stock (at least one of them), capturing the idealism of short-term traders and long-term investors alike. At any time Apple can announce new products that will bring strong buying into the stock. You think in terms of a bearish trade but remind yourself to use a tight stop, that is until you notice AAPL can gap pretty well at the open.
You then happen to notice that AAPL's Implied Volatility has really fallen off and is near the bottom of the past year's range (the gold line):
Recalling your option training, you think that a straddle could work here. Apple's options are typically richly-priced. It can be hard to make a profit on a straddle, which generates a net profit only if the underlying moves a certain minimum percentage in either direction within a short timeframe. But, you wonder, are there times you can increase the odds of success with a straddle trade on AAPL?
A straddle trade is where you buy equal amounts of calls and puts, at the same strike price, in the same expiration date, typically a near-term date. They work best when the Implied Volatilities on the underlying's options are near the lowest point of the past year's range, when the underlying is on a strike price, and the underlying is more likely to fall than rise (because a falling stock will typically increase Implied Volatilities, which aids a straddle position).
On Friday, AAPL closed at 454.45, which is very close to a strike price (455). There are only 5 days left until August monthly option expiration. That is too soon for a straddle trade to work reliably.
September monthly option expirations are 40 days away. If a straddle trade was going to work, AAPL should move enough within 20 to 30 days to make the trade profitable. With the September monthly's, we would pay for more time value than we need, which makes it harder to make a profit.
Ah, but AAPL has weekly options and they are very actively traded. Apple weeklies expiring the first week of September would give us 26 days for the trade to work.
Pricing a sample trade, using Friday's closing mid-point option prices and a Buy 1 AAPL September 6th, 2013 455 call and Buy 1 AAPL September 6th, 2013 455 Put trade would cost $20.30 to enter (times $100, or $2,030).
To raise the probabilities of such a trade working out, I like to target a 20% profit target on straddles, expecting to quickly hit the profit target and get out (say within 2 weeks).
Entering a 20% profit target within 2 weeks into an option pricing model, I see that AAPL needs to either rise to 477 or fall to 432.5. assuming nothing else changes, for this trade to work.
On this chart I've drawn the minimum levels AAPL must hit within 2 weeks for this September 6th straddle trade to be up 20%. Any trader would have to decide whether that is likely enough to happen to consider this trade.
In today's Seasonal Forecaster newsletter, I answer the questions “Can we further raise the chances of this trade working? Is there any way to know when a straddle trade on AAPL is more likely to work?”, provide a simple technique to do that, and address whether I think the September 6th 455 straddle trade makes sense right now.
Of course, there's much more you need to know and many more stocks you can capitalize upon each and every day. To find out more, type in www.markettamer.com/seasonal-forecaster
Copyright (C) 2013 Stock & Options Training LLC
Unless indicated otherwise, at the time of this writing, the author has no positions in any of the above-mentioned securities.
Gregg Harris is the Chief Technical Strategist at MarketTamer.com with extensive experience in the financial sector.
Gregg started out as an Engineer and brings a rigorous thinking to his financial research. Gregg's passion for finance resulted in the creation of a real-time quote system and his work has been featured nationally in publications, such as the Investment Guide magazine.
As an avid researcher, Gregg concentrates on leveraging what institutional and big money players are doing to move the market and create seasonal trend patterns. Using custom research tools, Gregg identifies stocks that are optimal for stock and options traders to exploit these trends and find the tailwinds that can propel stocks to levels that are hidden to the average trader.
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