AAPL Declares Its Independence

Just in case you didn’t have enough reasons to consider Apple Inc. (AAPL) stock for your portfolio, here’s another fascinating tidbit to mull over: the tech titan has declared its independence from the market.

That’s right.

AAPL and the S&P 500 Index have experienced a falling out of sorts. Whereas the two chums used to pal around together traveling northbound and southbound with synchronicity, they now frequently move in completely opposite directions. This curious change in behavior really started in late-2012 when AAPL began its distressing descent from $705.

Perhaps the easiest way to assess the changing relationship between both securities is using a correlation study. For those otherwise unfamiliar with this powerful indicator, a brief review is in order.

Measuring relationships plays a key role anytime investors are seeking to better understand how different asset classes are linked. It also aids in structuring a diversified portfolio because you need to know which securities move together and which move in opposite directions.

The correlation study measures the degree to which two assets are linked by oscillating in a range between +1 and -1. A score of +1 suggests both assets are perfectly positively correlated which means they always move in the same direction. In contrast, a score of -1 suggests both assets have a perfect negative correlation which means when one rises the other falls and vice versa. Finally, a rating of zero suggests both assets have no correlation meaning the behavior of one has no bearing whatsoever on the other.

As shown in the accompanying 5-year daily chart of AAPL its correlation began a metamorphosis in late-2012. During the “old normal” it boasted a strong positive correlation with the S&P 500 Index rarely venturing into negative territory. Now, however, it’s entered an entirely different phase – the “new normal” – where its correlation is all over the map, hovering near zero and below more than above.aapl

Far from being a good proxy for the market, AAPL has become a rebel stock hell-bent on marching to the beat of a different drummer. How long it lasts is anyone’s guess but while it persists in its independent ways investors in search of true diversification ought to consider adding the stock to their portfolios.

Gold Options 101: The basics of options trading using gold as a commodity

Not many people know that gold is also a viable commodity when it comes to options trading—this practice is not as common because of the volatility of gold prices. However, a basic understanding of how gold options work will enlighten investors of its benefits in the long run. What exactly are gold options? The Options Guide gave a thorough and simple discussion on this topic. Gold options use gold futures contracts as underlying asset; this means that the holder of the option has the right to call (long position) or put (short position) the gold futures subject of the contract at the strike price. The right will no longer be enforceable when the option expires, like in any other option contract.

What are the benefits of having gold options? For starters, they provide additional leverage because the payable premium is relatively less than the margin requirement. These option contracts can be used to hedge the price risk of gold, according to an article by T&K Futures and Options. Another analysis by Bullionvault.com, a gold trading and investment site, states that trading gold futures translates to purchasing gold on credit, so it gears up your gold investment. However, a warning is also issued: there is a risk of loss from the leverage due to volatility.

Gold options also tend to limit possible losses. Since it’s a mere right to assume the gold futures underlying the contract, losses are limited to the premium paid for the option. Even though recent financial reports by Forbes show a drop on the position of gold options and gold futures, investors are still optimistic that there will be a visible rise in the gold market in the coming weeks. The benefits, therefore, of gold options should not be immediately discounted. When the odds are weighed, it will still prove to bring more advantage than harm.

The Cause for the Pause


I knew there would come a time when I would awake from my blogging hibernation and that time appears to have finally arrived. Though I don’t know how frequently I will post going forward, I do want to at least bring everyone up to speed and explain my absence from the social sphere (my twitter feed has been dormant for months).  The original culprit for my absence was prepping for the level 3 exam of the CMT program – that’s Chartered Market Technician for you non-tech analysis types.    They only offer these tests every 6 months so I sure as heck didn’t want to fail and then have to wallow in my sorrows until the next opportunity.  Hence I overstudied.  Long story short I passed – booyah – and received my CMT designation as well as became a full-fledged member of the Market Technicians Association.

Quick thanks to my sponsors – J.C. Parets of All Star Charts, Corey Rosenbloom of Afraid to Trade, and Greg Harmon of DragonFly Capital.  You guys rock.

After completing the CMT program I basically just got busy with work and life and my poor little corner of the web received undeserved neglect.  Although I didn’t stop blogging altogether.  Puhleez.  Too much creativity in my noggin to not let it out from time to time.  I’ve still been generating content aplenty for InvestorPlace.

More recently I stumbled upon a second “designation”, albeit one that most people shun – CML.  This one came as a shock as it certainly wasn’t in the script I had laid out for my life.  For those that haven’t memorized all the medical acronyms (what do you have a life or something?), CML stands for Chronic Myeloid Leukemia.  Sounds sweet, no?

About a month ago I got sick for a week and a half with high fevers, coughing, night sweats, uncontrolled shivering… the works.  I figured it would go away, but alas, it clung to me like an obsessive girlfriend.  One day after shivering for about an hour and looking in the mirror to find out my face and lips were blue my wife decided it was finally time to head to the doc.  So I stumbled into the Urgent Care and found out my fever was like 104 degrees.  They suggested I may have pneumonia (not so bad, right?), stole some of my blood, pumped me full of fluids and sent me on my way.  Next morning the results of my blood test came back and they called us in to share the news that I had leukemia.  A couple hours later I was admitted to the Huntsman Cancer Institute – which is a veritable palace by hospital standards- where I ended up staying for 16 days while the docs poked and prodded to figure out the cause of my ridiculously good looks…. I mean the cause of my high fevers, sucky breathing, and what type of leukemia I had.

I ended up being diagnosed with CML which was actually quite the blessing.  CML is one of the more benign types of leukemia that doesn’t require immediate chemotherapy or a bone marrow transplant.  Plus they have pretty effective drugs to treat it.  I returned from the hospital last Monday and have been on the mend ever since.  The crazy thing is I feel pretty normal right now.  My body has recovered and I’ve been able to ease back into some work.  I’m not 100% mind you – I remind my wife of this any time she requests I help with something around the house like changing diapers.  I’m honing my skills on when and how to play the cancer card.  Consider it a side benefit of this whole topsy turvy ride.  I’m probably running on 80% right now, but it’s good enough for me.

There’s a ton of follow-up and monitoring so the wife and I make weekly and sometimes bi-weekly trips to Huntsman.  But, hey, we make it fun.  They just put in a new Dunkin’ Donuts shop right by the hospital and that place is packed every time we pass it.  No wonder their stock price is up so much.  For what it’s worth I think their donuts got nothin’ on Krispy Kreme, but perhaps I caught ’em on a bad day.

So that’s where things stand. I’m 28 years old and going to kick cancer’s butt over the next year.

What to Make of Similar Spread Pricing

Given the plethora of strike prices across the variety of expiration months, option traders face a bevy of choices when structuring a position.  The options market is a world of tradeoffs lacking a single solution for all participants.  Risk and reward exist on a correlated scale where a rise in one invariably results in lifting the other.  With this backdrop in mind let’s tackle a recent reader question regarding bull put spreads.

I’ve noticed that there are times when a weekly spread can be the same price as a monthly spread or a front month spread can be the same as second month spread. I feel sure that there is a trade there somewhere but I’m not sure..any thoughts? – Baruch

Rather than being a rare phenomenon the situation in question arises on a daily basis in virtually all optionable securities.  If, of course, the bull put spread is structured with strike prices close to the current stock price (at-the-money in other words).  Here’s an example on AAPL currently trading at $675.

Sep 675-670 put spread @ $2.42

Oct 675-670 put spread @ $2.42

Nov 675-670 put spread @ $2.50

Dec 675-670 put spread @ $2.50

As you can see the price of each put vertical spread is clustered around $2.45 regardless of the amount of time to expiration.  The essence of the question raised by Baruch is not just why the pricing is so consistent, but also what opportunities, if any, arise from such a situation.

The underlying reason behind the linked pricing of the aforementioned at-the-money vertical spreads has to do with probability.  In order to capture the maximum profit on the 670-675 bull put spreads outlined previously, AAPL has to sit above $675 by expiration.  With AAPL currently residing above $675 it’s fair to say there is a 50-50 chance it could sit above or below $675 at any point in the future.  Because the Sep spread has just as good of a probability of producing a profit as the Dec spread they are priced with a similar risk-reward proposition.

Now, if we were comparing the price of out-of-the-money bull put spreads, the pricing from one month to the next would differ substantially.  The addition of each month of time would increase the amount of reward available in the spread like so:

Sep 645-640 @ $.92

Oct 645-640 @ $1.52

Nov 645-640 @ $1.87

Dec 645-640 @ $1.97

With the spreads positioned out-of-the-money, time is now a decisive factor influencing the probability of profit.  With AAPL currently trading at $675 there is a much higher probability of it remaining above $645 for the next two weeks than for the next three months.  Since the Sep put spread boasts a higher probability of profit it delivers a smaller reward.

The key takeaway here is that risk, reward, and probability are all inextricably linked in the options arena.  A change in one of the variables will undoubtedly change the others.

Stay tuned…  Next time I’ll take a look at the tradeoff being selling the front month at-the-money bull put spread over a back month.


Somethin’ is Afoot in Small Caps

On a day when normalcy rules the roost, the broad market indexes exhibit a strong positive correlation.  Like slaves tethered together by chains the S&P 500 Index, Dow Jones Industrial Average, Nasdaq Composite, and Russell 2000 Index tend to move tit for tat.  While one Index may deviate mildly from the rest in the short-run, it eventually drags the rest along with it on its new path or is pulled back in line by the combined weight of the others.

Without a doubt the interesting development from Tuesday’s trading session was the stark outperformance of the Russell 2000 Index.  While its brethren closed lower on the day, the small-cap laden index surged 1.24% on high volume to boot.  Indeed, small caps marched to the beat of their own drum – a bullish one that was struck incessantly for the last four hours of the trading session.   The rally propelled the ISHARES Russell 2000 Index Fund (IWM) just north of multi-month resistance at the $82 level.

Conventionally relative strength in small caps is viewed as a positive for the market, a sign that risk appetite is on the rise as investors are piling into more volatile stocks that could produce quicker profits.  Some may conclude yesterday’s Russell rally was a sign of things to come, a peek at what the bulls have in store.  On the other hand, the utter lack of participation in the bullish festivities by the other indexes is a tad concerning.  Could it turn out to be a mere one-day aberration void of significance?  Sure.  Of course, it may also indicate something more ominous is afoot. Perhaps the Russell is about to be yanked back in-line to follow the more neutral path currently being trod by its bigger brethren.

Along with other chartists I’ll be watching for the inevitable resolution to yesterday’s divergence.

[Source:  MachTrader]

Apple Volatility Abuzz

The relentless bullish vortex known as Apple Inc. achieved an impressive benchmark on Monday by finally climbing atop the totem pole of valuation.  With yesterday’s rally its market cap lifted over $661 billion thereby overcoming the previous record holder Microsoft, which traded at a $618.9 billion valuation in 1999.

But, before all you Apple zealots don your party hats and pull out the pom-poms, keep in mind this is a record that deserves a large asterisk since the comparison doesn’t consider inflation.  As reported by Tech Crunch, with inflation adjusted numbers Microsoft is actually the king of the hill with its value rising to $856 billion in 1999.

Valuation aside, Apple’s implied volatility was also on the move in yesterday’s historic session.  The Apple VIX (VXAPL) was up over 30% at its intraday high revealing a strong surge in demand for option contracts.  The action in the derivatives market reveals two lessons of note.

1.  Implied volatility doesn’t always have a negative correlation to a stock’s price.

Typically a fall in a stock’s price will be accompanied by a rise in implied volatility as worried traders willingly bid-up option prices.  The widespread belief that volatility and stock price are inversely correlated is perpetuated by everyone’s fixation with the CBOE Volatility Index (VIX).  Anyone who has watched the VIX for longer than a nanosecond will attest that it tends to zig when the market zags.

Yet, yesterday’s liftoff in the Apple VIX came on the heels of a rise in the stock price.  Such a curious phenomenon isn’t so curious when you realize implied volatility is merely driven by supply and demand.  If traders perceive Apple is about to get “jiggy wit it” to the upside they’ll happily bid-up options to exploit the expected increase in realized volatility.

2.  Buying implied volatility when the AAPL VIX falls into the low 20s continues to be a profitable idea.

Option traders know the whole “buy low, sell high” mantra not only applies to a stock price, but also implied volatility.  Given its mean reverting tendencies implied volatility is easiest to predict at extremes.  Since its launch in 2010, VXAPL has oscillated between the low 20s and high 40s.  The fact that we’ve rallied so strongly off of the lower end of the range proves once again that buying volatility in some fashion when VXAPL falls to the low 20s can be a lucrative proposition.

[Source:  MachTrader]

The Return of Risk Appetite

The so-called “risk on” trade has ruled the roost in recent days.  A return of risk appetite to Wall Street has resulted in a mass exodus from safe havens like US treasury bonds and the US dollar as well as defensive sectors like utilities and consumer staples.  To the delight of the bulls this flood of money has found a new home in offensive sectors – who tend to outperform during healthier markets –  like technology, basic materials, and financials.  Not to be outdone, small cap stocks have also changed their stripes from a laggard to a leader over the past week.  All told, this shift in performance serves as a compelling piece of evidence supporting a more bullish backdrop to the US equities market.

This change in character is captured nicely in the following graphic comparing risk-on related areas like oil, financials, and consumer discretionary to risk-off related areas like bonds, the U.S. dollar, and utilities.  The chart covers the past week’s performance relative to the S&P 500 Index.

While one week does not a trend make, this change in character undermines the argument that the US equities market is unhealthy because safe havens are leading.  Provided this favorable turn of events persists bullish setups should not only multiply but also have a higher chance of success.  With dips being bought and rallies running long in the tooth, bull retracements and breakouts should perform well.

How long this resurgence in risk appetite lasts remains to be seen.  But, hey, while it’s here why not unleash your inner bull and start taking advantage of the quality bullish plays which have been and will continue to come across your path.