Why the Apple Trade is Toast

02/18/2013 8:00 am EST

Focus: OPTIONS

Mark Sebastian

Founder, OptionPit.com

If you love AAPL and are sensitive, stop reading this blog post right now, counsels Mark Sebastian of OptionPit.com.

I have an option mentoring student in town for the next few days.  He and I were walking through LivevolX looking at skew charts. I pulled up a stock that had a chart that looked like this:


chart
Livevol® www.livevol.com
Click to Enlarge

We then pulled up a second stock that had a chart that looked like this:

chart
Livevol® www.livevol.com
Click to Enlarge

Now, let’s take a look at the two skew charts. Which skew chart matches which stock graph?

chart
Livevol® www.livevol.com
Click to Enlarge

If you think the stock that was going up and up has the breakout, slightly forward skew, you are wrong. It is understandable that one would think that. That stock is GOOG, which is thundering higher. GOOG has every reason for option traders to speculate on a huge rally. The stock is at an all-time high, nearing 800. One might think traders would be bidding up calls in GOOG, but it has the traditional equity skew curve that causes implied investors to be long the stock and collaring their positions using options. This points toward logic and common sense being applied to option prices.

The second chart, that has been tanking, is obviously AAPL. A stock that is going nowhere at all, and when it has been going place, it has been going lower. Yet, AAPL stock fanboys, both institutional and retail, are so in love with this stock they keep buying upside calls despite, nothing propelling the stock higher. This is a classic example of the street thinking an old idea will continue to work. AAPL, the company, may be fine, but the stock's volatility is toast, as is the likelihood of AAPL rallying back to 700 in a way that would make a crazy skew curve, like the one above profitable.

The Trade

The AAPL trade is basically toast.

Buy calls in AAPL at your own risk. If you like the stock the curve should be sold (probably on a ratio), and that ATM's or ITM's should be bought. Also consider selling puts instead of buying calls. Better yet, stop obsessing about this company, the AAPL trade is probably going away for a while.

By Mark Sebastian, Blogger and Contributor, OptionPit.com

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