Last week I suggested buying a SPY Weekly strangle to take advantage of the unusually low option prices that exist today.  Last Monday, I bought a Mar4-12 141 call and 140 call for $1.09 ($111.50 including commissions).  For the first three days, the stock did not budge beyond the $1.50 in either direction that I needed to make a profit on the trade.  Finally, on Thursday it fell enough so that I could at least break even so I placed an order to sell the strangle for $1.14 which executed, exactly covering my cost after commission.  If the stock had fallen that much earlier in the week, I would have held off selling it in hopes of a nice profit.  But I was happy with a break-even trade in a very quiet week.  I plan to place a similar strangle buy on Monday (today).

You may be bored from hearing about another AAPL trade.  But here is another one this week.  Terry’s Tips carries out two option portfolios that use AAPL as the underlying.  Last week was a quiet week for AAPL.  It went up only 1.8%.  Both of our actual portfolios gained over 23% after commissions for the week.  We don’t think that is boring.  Most investors would be happy with that size gain for two years, not seven days.

One of our AAPL portfolios has been running for just under two years, and has gained just shy of 700% while the stock doubled in value.  So we are partial to this stock.

Today I will discuss an AAPL option play that is similar to one in one of our actual portfolios.

Another AAPL Spread Idea

AAPL option prices are high compared to historical levels.  Since there is an earnings announcement coming late in April, option prices tend to move higher.  The stock also tends to move higher in advance of earnings announcements.  So we set up the following portfolio with a slightly bullish stance. 

To keep it simple, with AAPL trading at $596 where it closed Friday we will buy three calendar spreads.  We will buy the Apr-12 options (which expire April 21, 2012) and sell the same-strike Mar5-12 options which expire on Friday, March 30, 2012. 

We will buy one calendar spread using puts at the 595 strike, and one calendar spread using calls at both the 600 and 605 strikes.  These spreads will cost an average of about $11.25 ($1125 plus a commission of $2.50 which is what thinkorswim charges Terry’s Tips subscribers).  So the total investment will be about $3500, and we set aside another $1200 or so in case we need to add another similar spread this week at a higher or lower strike price (based on which way the stock moves).

This what the risk profile graph shows for the above three calendar spreads:

The P/L Day column in the lower right-hand corner shows the expected gain if the stock remains at $596 or goes up or down by $10 during the week.  You can see that there should be a gain if the stock ends up within a range from about $585 to $612.  If the stock stays about flat or goes up by $10, we could make as much as 25% on our investment in five short days.  If it moves by a much larger amount we could lose money, however.

If AAPL moves about $5 higher or lower before we buy these spreads on Monday, we would raise or lower the strike prices we used by that amount, using puts for spreads at strikes below the stock price and calls for strikes which are higher than the stock price.

If, during the week, the stock moves by $10 in either direction, we would use the cash we set aside to buy another calendar spread using the same option series at either the 620 strike (using calls) if the stock has gone up by $10 or at the 580 strike (using puts) if the stock has fallen by $10.  The additional spread would provide some protection against a loss if the stock continued to move in the same direction.

If you think AAPL is headed higher next week you would start out with spreads at higher strike prices than we have used in our sample, and vice versa.  We take the position that we really don’t know which way it is headed, but we know from experience that the weeks leading up to an earnings announcement are usually up weeks, so we have set up spreads which make about as large a gain if the stock goes up by $10 as they do if the stock remains flat.

Happy trading if you choose to duplicate our positions.  Of course, you should never risk money that you can’t afford to lose.

We have made 3 short videos which explain the 3-week results of our AAPL trading. The original positions were set out in an actual account carried out at Terry’s Tips.  The YouTube link is http://youtu.be/6J9KPuimyXk

The portfolio was updated in the Week 2 video –
http://youtu.be/e0B7_6e_5AE 

And finally, adjustment trades we made were displayed in this little video –
http://youtu.be/YC3d2NuX2MI  Be sure to enlarge it to full-screen mode so you can see the numbers. 

Option prices for the market in general (SPY) are lower than they have been for five years.  Maybe it is time to change from a strategy of selling short-term options (the strategy carried out at Terry’s Tips) to one of buying those options and hoping the market is more volatile than those low option prices would expect.

We will discuss that possibility today.

How to Contend With Historically Low Option Prices

Before discussing the situation of low option prices for most equities, I should comment on the continuing high option prices for Apple.  Implied Volatility (IV – the most important determinate of whether option prices are “high” or “low”) is about 40 for AAPL.  This means the market is expecting AAPL to fluctuate about 40% over the course of a year.

The high option prices for AAPL has meant that our calendar spread strategies has been quite successful of late (we move our calendar spreads to new strike prices as the stock moves higher).  We carry out two AAPL portfolios at Terry’s Tips – one gained 8% last week and the other gained over 20%.  The one that gained 8% has been operating for one month less than two years and is now ahead by 642%.  It is our most profitable portfolio by a large margin. 

Compare this 40 IV number for AAPL to IV of the S&P 500 tracking stock, SPY, which is called VIX.  It is less than 15, and briefly fell below 14 last week for the first time since I can remember.  This is extreme low territory (the mean average is about 20).

The IV picture for SPY gets even more interesting when you check out the Weekly options.  When VIX is calculated, the Weekly option prices are not included (only options with 8 or more days of remaining life or included).  IV for the SPY Weeklys is only 12.47.

Last week SPY rose $2.70 and the week before, moved by $3 in both directions during the week.  If you bought an at-the-money straddle or strangle using SPY Weeklys at today’s prices in either of those weeks, you would surely have doubled your money in a single week.

With SPY closing at $140.30 last Friday, you could have bought a 140 Weekly straddle (both a put and call at the 140 strike) for $1.80 or a strangle (the 141 call and the 140 put) for $1.33.  If the stock moved by at least $1.50 in either direction next week, either of those purchases should result in a gain.  SPY moves by that much in just about every week, even in quiet markets like we have been having so far this year.

_ _ _

It is an interesting trade to try.  I plan to buy a few this week (in both my personal account and in one of the Terry’s Tips portfolios), just to test it out.  Of course, you should never risk money that you can’t afford to lose.

We have made 3 short videos which explain the 3-week results of our AAPL trading. The original positions were set out in an actual account carried out at Terry’s Tips.  The YouTube link is http://youtu.be/6J9KPuimyXk

The portfolio was updated in the Week 2 video –
http://youtu.be/e0B7_6e_5AE 

And finally, adjustment trades we made were displayed in this little video –
http://youtu.be/YC3d2NuX2MI  Be sure to enlarge it to full-screen mode so you can see the numbers. 
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Any questions?   I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.

You can see every trade made in 8 actual option portfolios conducted at Terry’s Tips (including the two AAPL-based portfolios) and learn all about the wonderful world of options by subscribing here.   Why wait any longer to make this important investment in yourself? 

I look forward to having you on board, and to prospering with you.

Terry

The March options expiration cycle ended without much fanfare, but not after reaping a respectable 2% gain. All of the major indices saw gains exceed 2% with the small-call Russell 2000 being the exception. The market has now pushed higher nine out of the last ten weeks. The Nasdaq and S&P 500 have led the way all year and are now higher on the year 17.3% and 11.7%, respectively. Both have also pushed above key levels. The Nasdaq sits above 3000 and the S&P is now above pre financial crisis levels trading over 1400.

There is no doubt that this rally has been one for the ages. For instance, last week marked the first time the S&P closed below its 20-day moving average. The streak: 52 days. It was the second longest streak of all time. The last time such a streak occurred – 1944!

Moreover, last week broke the 1% daily decline and ended the 10th longest such streak. If that wasn’t enough, last week also saw the first “90% down day” this year. Another historical streak. We can all thank the slow and steady rise in the market for the historical accomplishments.

“We are seeing this unbelievable rally in the market and yet the market is unbelievably complacent. We haven’t been this bullish for a long time,” said Randy Frederick, director of trading and derivatives at the Schwab Center for Financial Research, based in Austin, Texas.

But, where are we now? How will the market fare over the next few months? Are there any historical precedents that we should be aware of going forward?

Well, I am not a prophet. I can’t predict the future. But, I can tell you how the next few weeks fare on a historical basis. Hopefully this will give you a “heads up” as to what to anticipate going forward.

The day after expiration is typically bearish. March is no different; in fact, the week after expiration has seen the Dow down 15 of the last 24 years. But weakness continues throughout the rest of the month. The end of March is actually one of the weaker periods for the stock market.

Will it happen again this year? No one knows for certain, but with Apple making up roughly 18% of the Nasdaq 100, when the tech behemoth’s parabolic move comes to an end we should see a sharp decline in not only the Nasdaq, but the S&P as well. Remember, since the latest rally began Apple has managed to tack on approximately 54%. Yes, 54%. I am very curious how the largest company in the universe manages to be mispriced by several hundred billion dollars. Yet, Wall Street analysts keep pushing estimates higher.

My thought – we will be discussing this magnificent run five years from now when Apple is trading with a market cap far below $500 billion. Like its predecessors in the exclusive $500 billion club, it is my opinion that Apple will eventually suffer the same fate.

But don’t just listen to me, listen to what the market is saying.

While the investor’s fear gauge, VIX has been sliding to five year lows, the expected volatility in Apple has increased, judging by a VIX index that tracks Apple options. Apple, like IBM and other bellwether names, has its own VIX index.

The CBOE Apple VIX index , which measures the expected 30-day volatility of the underlying shares of Apple, jumped 35 percent this week, suggesting more gyrations ahead as more investors speculate on short-term moves.

The end of March should be very interesting. April is typically a strong month and then we enter the “sell in May” period. One thing is certain, 2012 should be one for the record books. I can’t wait to see how it plays out

Three weeks ago, we set up a special portfolio with a goal to make 100% on AAPL options in 4 weeks.  We closed out the positions last Friday, a week early.  We failed to reach our goal.  The portfolio started out with a value of $4488 and after 3 weeks, it was worth $7172.

The gain for the 3 weeks was 60% (after commissions).  Even though we failed in our initial goal, most of us were happy with making 60% in less than a month on our money.

For two years, Terry’s Tips has carried out at least one portfolio (and sometimes two) which use AAPL as the underlying, and we have noticed some patterns of stock price actions and option values that I would like to share with you today.

Lessons Learned Around the Apple New Product Announcement

AAPL has been a great underlying stock for Terry’s Tips subscribers.  In April, 2010 (just under two years ago), we set up an actual brokerage account to trade options on AAPL.  We started with $5000 in the account. 

Terry

The bulls were once again successful in pushing the market higher this past week. It marked the ninth advance in ten weeks. The S&P 500 is already 9.0% higher year-to-date and the Nasdaq 100 is up a staggering 14.7%. The bulls have been in control since December 19th, in what has been one of the most persistent rallies in market history.

This past week did have some significance for the bears. Trading on Tuesday was relatively dramatic in that the S&P 500 fell 1.5% to suffer its worst one-day drop in almost three months. The action came on the heels of weak action abroad, where markets remained concerned about the implications of slower growth in China and news that Eurozone GDP declined by 0.3% in the fourth quarter, unrevised from its preliminary reading. The disconcerting macro picture came as the stock market began to show fatigue during its run to a new multi-year high in the preceding week.

Widespread weakness and concern that stocks were possibly setting up for a correction caused the VIX to spike more than 15%, putting it back near its monthly high.

However, the pullback was short-lived as the market bounced back over the next three trading days. It was the best string of gains in over three months. So, for now, the bulls reign supreme.

Friday also marked the three-year anniversary of the S&P 500’s plunge to a 12-year low, a move that was followed by a sharp rally. The S&P 500 still is up 102 percent from that low.

“Everyone’s looking for a correction here, which just tells me we’re probably going to have another little run up before we get that correction,” said Scott Billeaudeau, portfolio manager at Fifth Third Asset Management in Minneapolis.

Technically speaking, the market is hovering near key resistance levels, which could influence next week’s direction. A push above 1,376 by the S&P 500 could suggest further gains ahead, while holding at or below that level could indicate a continuation of Tuesday’s selling.

Moreover, we have a short-term overbought in all of the major indices, although that indicator hasn’t really worked well so far this year. Furthermore, almost every indicator I follow has once again pushed into a short-term overbought state.

If the aforementioned bearish technical were not enough, we are entering into one of the weakest stretches on a seasonal basis for the market.

My thought is that we will see a choppy to lower market over the coming weeks. Trade accordingly and remember, trade small and trade often. Always, use position-sizing as your most important risk- management tool.

Greetings!

A little over two weeks ago, we set out with a goal to make 100% on our AAPL options in 4 weeks.  We started with calendar spreads at several different strike prices, one below the stock price and most of them at higher strikes.

We thought we could double our money in 4 weeks if the stock would hold steady or move moderately higher.  As you may know, it overachieved this goal and rose over $20 in each of the first two weeks.

Today we will discuss the adjustments we had to make to keep up with the skyrocketing stock.

By the way, in spite of the stock moving much higher than we would have liked, we have gained 78% (after commissions) on our actual portfolio over the past two weeks, about 9 times as great as the increase in the stock price.

Next week, we will disclose the actual positions we will set up in an effort to duplicate this performance in the next 4 weeks.  Stay tuned.

Terry

Making Adjustments When the Stock is Moving Strongly Higher

As AAPL chugged steadily higher, our calendar spreads (all in calls) so became all in the money (i.e., at strike prices which were lower than the stock price).  Since we were betting that the stock would stay flat or rise moderately, we needed to buy back our lowest-strike short calls and replace them with higher-strike short calls.  Each such trade required us to put up a little extra cash because the calls we were buying back cost more than the premium we received from selling new higher-strike calls.

Again, switching to full-screen mode is advised.