Post-Labor Day Strategy for Apple Traders

There’s growing sentiment that Apple (AAPL) and the markets, particularly the Tech Sector, will rally going into the latter part of 2008. In the near term, there’s technical indicators that the major indices will start this rally soon, as the weekly and monthly charts favor such a move. But we can expect some turmoil from Gustav, and the back and forth action that is indicative at the tail end of a bear market.

So, if we’re not exactly sure where AAPL will be in the near term, but reasonably confident that it will advance soon after, what types of trading strategies should we employ?

From a technical point of view, AAPL has been developing a solid base over the past several months from which to advance. However the retreat last week among the Horsemen of Tech (AAPL, GOOG, BIDU, and RIMM) has shown some cracks in the Tech leaders, as some fell below their respective 50-day moving averages. AAPL ended smack dab on its 50-day SMA, but lost its 50-day EMA, and the Nasdaq gapped down after a great advance the day before. So unless we see some uniformity among the Tech leaders, we may see some more sideways action for a while.

So, what kind of trading strategy do you employ when you’re unsure of the near term, but confident that the general direction is bullish? If trading options was not an option for you, then you would likely sit on the sidelines waiting for a confirming indicator before committing your capital. But with options, there are trades you can execute that will make money even if AAPL's price is stagnant, or simply wavers back and forth.

The trade strategy to employ in such a case is called a Bull Put Spread. With this strategy, you can make money three ways, whereas buying plain old stocks, you can make money only one way - if the stock price goes up. With a Bull Put Spread you make money in all the following cases:

1. Price stays stagnant or moves up
2. Price goes down, but stays above strike price
3. The contract expires

A Bull Put Spread is a multi-leg trade, very similar to a Bull Call Spread, in terms of the profit and loss levels. But a Put Spread has advantages, and some disadvantages over the Call Spread. A Bull Put Spread is generally executed by selling a Put at or near the money, and buying a Put out of the money. In this case, that would mean the buying and selling of the following contracts:

Bullish Put Spread - AAPL Sep 2008 160/165
Strike Price	Symbol	Option Value	Delta	Theta
$165	APVUM	$3.4753	-0.3511	-0.1335
$160	APVUL	$2.0359	-0.2312	-0.1137

Net Credit Trade
One of the advantages of this trade is that it’s a net credit trade, meaning that it costs you nothing, other than the capital it ties up during the time you hold the position (due to margin requirements). In fact, your broker will deposit funds into your account after you execute the trade. And though you can’t use those funds until you either close the trade, or until the expiration of the contract, it will accumulate interest.

Time Value of the Contract
This trade is timely. That is, it plays on the time value left in option contracts, which will diminish to zero as the contract nears the Options Expiration [OE] date. This is the day when all September 2008 options contracts will expire, which is September 19th. So, as long as the price of AAPL does not fall below the break even point by OE, the contract will be profitable.
 
Support Levels
So, AAPL is currently at $169.53, sitting at or about the 50-day moving average, which is actually $169.74. The 200-day moving average is below this at $163.76. This is important because that represents very strong support that will help prevent this from becoming a losing trade. Now, if you’re generally bullish, then you think as I do that over the next couple of weeks, AAPL is much more likely to advance a bit than decline. And if AAPL price can get above the 50-day and plot some distance from it, then this will become strong support. 

The Trade
This type of trade is considered a conservative strategy and thus low risk and limited profit. However, the amount of profit and potential gain vs. the amount of capital needed to execute the trade is quite good for such a low risk position.

The table below shows the trade and the outcomes based on the current values of the options. The calculations are pretty straightforward. The break-even point is the price of the underlying security, which is obviously AAPL, where you make money above this price, or lose money below this price. The ideal would be that the contracts expire and that the price of AAPL stays above $165. Then you would realize the full profit potential of the trade.

If the trade starts to go south, it should be quite easy to exit the position, as the open position is quite large, and thus these contracts should be quite liquid. So, if you don’t feel comfortable at any time between now and expiration, simply close the trade.

Click here for a simple excel spreadsheet that was used to calculate the values.

Chain	Symbol	Break Even	Max Profit	Max Loss	Return on Risk
Sep 160/165	APVUL/APVUM	$163.54	$145.57	$354.43	41.07%

Intra and Post Trade
If the trade works out and AAPL's price advances above its current 20-day moving average, currently at $171.69, then I would suggest you consider the trade in the table below, by purchasing either AAPL stock, or Call options purchased with the proceeds from the Put Spread. I have posted a variation of this trade in other posts. It’s based on strong support levels, and the potential for the positive divergences on the weekly charts of the S&P and Naz to kick in soon.

AAPL Long Swing Trade
Best Entry	$172.00-$176.00
Target	$190.00
Stop	$168.00
Risk:Reward	Medium - High

Comments

[Murphy Mac:]

Articles like this make me glad I don't play with options. I'm long, plain and simple.

2008 Sep 02 07:04 AM

[Brandon:]

Makes you wonder why gambling is illegal huh? hahaha

2008 Sep 02 10:19 AM

[Donald Johnson:]

Great piece. Best I've seen on spreading options. Very educational and tactical. You show possible rewards vs risks, which is important. I'm going to review your site and other articles.

Why do such a narrow spread? Why not 160/195?

2008 Sep 02 12:10 PM

[pabs:]

zach
i dont mean to be rude but i've followed you column for a little while because it sounded promising but ultimately it fails to deliver

question, do you make a living solely as a trader or do you have another profession

2008 Sep 02 01:33 PM

[Zach Bass:]

So pabs, how does it fail to deliver? What do you expect me to deliver in terms of what I effort to provide, which is analysis of AAPL and the markets, commentary and investment strategies?

2008 Sep 02 03:46 PM

[Zach Bass:]

Donald, if I chose to sell a put that deep in the money, the return would potentially be bigger, but the stock price would have to move higher to realize that max return.

By doing it near the money the price doesn't have to move much at all to realize the max return. Also, my margin requirements might make the position too expensive, even though it's a net credit trade.

2008 Sep 02 03:58 PM