11 Minute Read

Options Theory: Eating a Rotten Apple

January 3, 2019

By | No Comments

Options Theory: Eating a Rotten Apple

The magical fruit is rotting. But we’re going to eat it anyway. I’ll have to mix-in some options to make the meal tasty enough, but I think we can come up with something both palatable and profitable.

Last night Apple issued lower revenue guidance ahead of its forthcoming earnings report. These type of pre-announcements are rare and unscheduled, so there’s no warning ahead of time that big news is looming and thus a volatile price move is imminent. If you’re an Apple shareholder, my condolences over this morning’s -10% sucker punch.

With the overnight thrashing AAPL stock’s bear market losses have extended to 39%. For comparison, the stock fell 61% during the 2008 financial fiasco. Were it to experience a similar such demolition it would descend to around $92. Currently, it’s at $142. Not that I think it will, by the way. Say what you will about the current economic environment, you doomsayer, but it isn’t anything close to ’08. I use the comparison simply to paint a disaster scenario to ballpark just how low it would take the stock.

In situations such as this, where a cash-flush large-cap beauty has been brought low, where fear is flying and shareholders are dying, I like to trot out the old Fade the Fear trade.

The idea is to start selling puts or put spreads in anticipation that the fear is overblown, that AAPL won’t fall as far as expected over the coming weeks. For example, if you think AAPL won’t fall below $115 over the next 43 days, you could sell the Feb $115 puts for around $1.00.

Think of it this way. You’re betting that the 39% drop in the stock won’t morph into a 51% one over the next 43 days. If it doesn’t, the put expires worthless and you get to keep the $100 premium. And if the cost of the naked put is a concern (which it probably is if you’re in a retirement account) you could morph it into a wide bull put spread to control the margin requirement. For example, sell the Feb $115 put for around $1.00 while buying the Feb $85 put for a nickel. You receive almost the same premium but at a pittance of the cost.

And if you want to increase your odds of success further then scale-in. Suppose you wanted to sell three contracts total.

Tier One: Sell 1 Feb $115 put for $1.00

Tier Two: Sell 1 Feb $115 put for $1.50

Tier Three: Sell 1 Feb $115 put for $2.00

By using the scaling method, you’ll use any further loss in the stock over the coming weeks to your advantage by entering the rest of your position at better prices. The only downside is if Apple bottoms immediately you may never have the chance to add the second two tiers. So you’ll only win on a one-third position.

Cry me a river.

If you do follow the scaling method, I suggest you apply it to the exit as well. Maybe something like so:

Tier One: Sell 1 Feb $115 put for $1.00. Target: 20 cents

Tier Two: Sell 1 Feb $115 put for $1.50. Target: 70 cents

Tier Three: Sell 1 Feb $115 put for $2.00. Target: $1.20

In timing the entry, it’s worth waiting for some upside confirmation such as a break of intraday resistance or a prior day’s high. Remember, we’re trying to get somewhat close to the bottom of Apple’s downswing, so if it plunges over the next few days you’ll wish you waited on pulling the trigger.

If you need another example, I recently showed a similar trade setup in the S&P 500.

Tackle Trading: Financial Freedom is a Journey. Sign up now for a 15-day free trial.

Financial freedom is a journey

The Options Theory series is brought to you by Tackle Trading.

Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.

Sign up now for a 15-DAY FREE TRIAL #

Legal Disclaimer

Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.

All investing and trading in the securities market involve a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax, and accounting advisers, to determine whether such trading or investment is appropriate for that user.

Leave a Reply

Chart Modal

Tackle Trading