On April 4th I published an article titled “Apple is Toast (Well Maybe, Sort of) http://www.optionetics.com/marketdata/article.aspx?action=detail&aid=24324.
In that article I noted that AAPL might be running out of steam and that at least a short-term decline was possible and highlighted a potential trade to take advantage of said potential decline.
On April 24th I published an article titled “Apple Really Was Toast (Well Maybe, Sort of) http://www.optionetics.com/market/articles/2012/04/24/kaeppels-corner-apple-really-was-toast-well-maybe-sort-of
In that article I (wisely, as it turns out) fought the urge to gloat over the fact that Apple had declined sharply in the interim, because, well, to paraphrase a popular saying, “I’ve seen some stuff.” As in, I’ve seen a lot of things that I didn’t expect to happen, well, happen.
In the 4/24 article I did suggest an adjustment to the original trade which was designed to lock in a profit. Good thing too. Because “stuff happened.” This morning AAPL opened – how shall I say this – a "tad" higher. Now I suppose it all depends on your definition of “a tad”, however, in this case that tad worked out to be about $56 a share or about 10% higher.
The Net Result
Figures 1 and 2 display the adjusted trade as of the time I am writing. However, in the 4/24 article I suggested exiting if AAPL exceeded $610 a share. I mean, what are the odds? Er, I mean “Mission Accomplished”.
Figure 1 – Original Position with Adjustment
Figure 2 – Risk curves for adjusted AAPL OTM Butterfly
In a nutshell, if:
-The original May 610-560-510 OTM butterfly spread was entered in a ratio of 4x8x4.
-The trade was adjusted on 4/24 (the adjustment was suggested because AAPL had hit the middle strike of 560) by close ¾’s of the position, thus leaving a 1x2x1 spread.
-The trade was exited when AAPL gapped open above $610.
-The hypothetical profit on this position was $1,431 on an original investment of $3,844, or 37% in 21 days.
Summary
Is this the greatest trade anyone ever suggested? No. But it certainly is not the worst. So let’s review a couple of simple but useful lessons:
-When a security keeps making new price highs but the 3-day RSI (for example; other momentum indicators may also be examined and used) keeps registering lower peaks, this is often (please notice that I said “often” and not “always”) a sign that the security is running out of momentum and that at least a short-term decline may be imminent (please note that I said “a short-term decline may be imminent” and not “OH MY GOD IT’S THE TOP FOR SURE!!!!!” Yes, Virginia, there is a difference).
-An option trade - whether it be as simple as buying a put option or doing something a bit more complex like the out-of-the-money butterfly spread used in this series of articles – can afford a trader the opportunity to take advantage of short-term pullbacks, and depending on the trade maybe even making a lot of money, while risking only a limited amount of capital.
-Trade management should be thought out “in advance” and not “in the heat of battle.” For the AAPL OTM butterfly I determined that the trade should be adjusted if the stock got down to the middle strike of 560.
-If your trade management plan calls for you to do something if a certain trigger is reached/hit/activated/etc., (like for instance, adjusted your out-of-the-money butterfly spread if AAPL trades down to the middle strike of 560) then you MUST act at the appropriate time.
-re: Trade Management Planning in the micro sense, adjusting the AAPL spread when the stock hit $560 allowed this trade to exit with a profit of roughly $1,400 versus about $600 if the trade was left unadjusted. In other words, a trader who decided to “wait a day” just to “see what happens” would have missed out on $800 a profit when AAPL gapped higher.
-re: Trade Management Planning in the macro sense, training yourself to follow your plan religiously – even if you coulda/woulda/shoulda done something else in hindsight that might have worked out better this time around – is one of the key traits that separates the winners from the losers in the long run. NOTE: Please reread this last part until you pretty much have it memorized.
Jay Kaeppel
Staff Writer and Author of “Seasonal Stock Market Trends”
Optionetics.com ~ Your Options Education Site
NOTES:
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