It's Options Expiration Week and Apple Doesn't Care

Jul.11.11 | About: Apple Inc. (AAPL)

If I go down as the man who called the bottom in Apple (NASDAQ:AAPL) as it heads to $500, $550 or $600 a share (forget $400), so be it. I'll be in good company. Everybody can think of somebody worthwhile and useful who put himself in the wrong place at the right time. Heck, Springsteen got booed off of the stage when opening for Chicago at the Philadelphia Spectrum back in 1973. Look at how things turned out for Bruce.

Just like you should always sell volatility in the options market, I think you should sell euphoria when a stock has fooled you once, fooled you twice. It does remain to be seen if this AAPL run is for real. It's not a forgone conclusion that the head fakes are behind AAPL bulls. Cockeyed optimists and stubborn pessimists alike can agree on one thing - as earnings season commences, this is going to be an interesting kick-off week.

Not only does Alcoa (NYSE:AA), keeping with tradition, get things going, but giants JP Morgan Chase (NYSE:JPM) and Google (NASDAQ:GOOG) report on Thursday and Citigroup (NYSE:C) reports on Friday, ahead Apple's highly anticipated July 19th earnings release. To top it off, it's options expiration week. The last day to trade July options contacts comes this Friday, two trading days ahead of Apple's report.

It has become sport to follow maximum pain as it relates to AAPL. On its recent run, however, AAPL refuses to cooperate with academic theory. Oddly, cries of manipulation have vanished as well.

(Charts courtesy of FreeStockCharts.com and OptionPain.com)

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A couple of weeks ago I introduced the possibility of strangling AAPL ahead of earnings. Today, I provide you with some specific ideas. In all honesty, my conviction regarding AAPL retreating from this apparent run to $400 and beyond is not that strong. First, I want Apple to succeed. I deeply admire the company. And, second, I think the best AAPL bulls make pretty strong cases for this time being for real.

Initiating a strangle on AAPL the week prior to earnings makes some sense in my book. If you're lucky, you might be able to generate a profit from both ends of the trade. I did this several months back with Amazon.com (NASDAQ:AMZN). The stock moved with quite a bit of volatility the week ahead of and around earnings, which allowed me to exit both ends of a strangle profitably. Check out this crazy chart, which shows AMZN's price action from January 18, 2011, to January 31, 2011. Amazon reported Q4 2010 earnings on January 27, 2011.

(Chart courtesy of Schwab's StreetSmart Edge)

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I can envision a scenario where max pain moves up a bit* and the stock retreats closer to that point prior to earnings. Once AAPL reports all bets are off. Best case scenario, you game the price action ahead of earnings and do what I did with AMZN. Granted, I was lucky. Timing the market does not always work out well, but you can always fall back on the original purpose of the strangle - making a non-directional bet on a stock that you're certain will move considerably around a major event such as earnings.

You'll have to study not only the strike prices of each end of the trade, but the spread you're comfortable having between them. I would start by considering the AAPL August $350 call/$360 put strangle. You buy both ends to open. If you prefer to play the actual even head on, you can wait until Friday, Monday or even Tuesday to initiate the trade. If you like my idea, there's no time like the present. With a strangle, you can open the trade as one transaction. To close it, you have the option of closing it as a combination or in separate transactions with most brokerages.

*Monday morning update: AAPL trades lower to $354.90 and max pain is up to the $340 strike.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.