Tim Bovee, Private Trader: AAPL, YHOO: Volatility plays

The consumer electronics company Apple Inc. (AAPL), headquartered in Cupertino, California, and the digital content company Yahoo! Inc. (YHOO), headquartered in Sunnyvale, California, both publish earnings on Tuesday, Jan. 27 after the closing bell.

Both have Weeklys among their options inventories, and I shall trade the FEB1 series of options, which trades for the last time on Feb. 6, nine days hence.

[AAPL, YHOO in Wikipedia]

AAPL

Volatility

Implied volatility stands at 44%, in the 98th percentile of the rise from 27% on Dec. 23, 2014 to 44% on Jan. 15.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	114.20	115.04	114.36
Lower	112.50	111.66	109.21
Gain/loss	0.8%	1.5%

Implied volatility 1 and 2 standard deviations; chart support and resistance Direction

Click on chart to enlarge.

AAPL at 10 a.m. New York time, 30 days, hourly bars

AAPL hit a longer-term peak of $119.17 in November 2014 and has since been in a counter-trend correction. Elliott wave analysis suggests it could be a major peak going back at least four degrees of magnitude, with present correction being a shallow 4th-wave correction. At this level the bias is toward the downside.

However, the correction has lasted two months and has taken the form of a three-wave pattern, which is sufficient under Elliott to meet the minimum requirements for completion..

If the correction has indeed run its course, then the next move will be the 1st wave to the u pside of a 3rd wave of higher degree.

Nearer term, AAPL, hit its first peak of the correction 30 days ago and has continued zig-zagging since then, completing its 4th wave -- this one to the upside -- on Jan. 26 at $114.36. The prior low was $105.20 on Jan. 16.

The Jan. 16 low could be the lower boundary of the chart range. An alternative would be a low of lesser degree within the ensuing upward wave, at $109.21 on Jan 16.

The price began another leg down on Jan 26, in the area highlighted in yellow on the chart. The peak set a higher high from the Jan. 9 peak and yet failed to pierce the Dec. 29, 2014 resistance level, making the trend ambiguous.

The most recent movement was to the upside, and the intra-day trend from Monday was to the downside. The whole of the past month could also be seen as a sideways movement. It's ambiguous.

Zacks Investment Research gives AAPL its most bullish rating. The enthusiasm rating among analysts is 31%, down from 50% a month earlier. Of analysts following AAPL, 66% rate it a strong buy, the strongest bullish rating. I'm rating the 30-day trend as rising (a judgement call, to be sure) and the intra-day trend to be falling.

Combing the Zacks rating, enthusiasm index, the percentage of strong bulls and the chart trends produces a directional score of 4, which argues for a bull play. That also coincides with my sense of the AAPL narrative, with new products, including the long-awaiting watch, said to be ready for announcement in April and commentators anticipating large sales of the iPhone 6 series, especially in China.

I shall structure my trade as a bull put spread.

The Trade

In given the price decline from Monday within a bullish directional score, I'm very much concerned about protecting the downside. Rather than setting the hedge at the nearest downside resistance -- around $109 -- and gone down to the lower, more significant resistance level of around $105. This places both standard deviation ranges within the zone of profitability at expiration, while also protecting an expanded chart range.

Bull put spread, short the $00 puts and long the $00 puts
sold for a credit and expiring Feb. 7
Probability of expiring out-of-the-money

FEB1	Strike	%
	105	69.0

The risk/reward ratio stands at 57:200 (about 3:1).

YHOO

Volatility

Implied volatility stands at 51%, in the 86th percentile of the rise from 31% on Dec. 5, 2014 to 54% on Jan. 15.

Ranges implied by options and the chart

Week	SD1 68.2%	SD2 95%	Chart
Upper	48.86	49.15	49.79
Lower	48.28	47.99	45.85
Gain/loss	0.6%	1.2%

Implied volatility 1 and 2 standard deviations; chart support and resistance
Direction

Click on chart to enlarge.

YHOO at 10 a.m. New York time, 2-1/2 months, hourly bars

YHOO attained a decades-level peak of $52.62 in November 2014 and then began a decline which has taken the form of a steady movement to the downside that accelerated from $50.41 on Jan. 9.

The two trend channels on the chart show the acceleration of the decline. Note that the rise from the Jan. 16 end of the accelerated decline has broken significantly above the trend channel, lending strength to the argument that the trend is to the upside. However, absent a break above the Jan. 9 peak, which would be a higher high, I must see the trend at that level as down. It's extremely ambiguous.

The intra-day trend, in the area marked in yellow on the chart, is also down.

Zacks Investment Research gives YHOO a neutral rating. The enthusiasm rating among analysts is 17%, down from 36% a month earlier. Of analysts following YHOO, 58% rate it a strong buy, the strongest bullish rating. I'm rating the 30-day trend as falling (a judgement call, given the ambiguities), and the intra-day trend to be falling.

Combing the Zacks rating, enthusiasm index, the percentage of strong bulls and the chart trends produces a directional score of zero, which argues against making a trade in either direction. The score results from a divergence between the chart and the analysts.

Decision for My Account

I've opened a bear position in AAPL as described above. I've declined to open a position in YHOO.

-- Tim Bovee, Portland, Oregon, Jan. 27, 2015

References

My volatility trading rules can be read here. For a discussion of the rationale behind the rules, see my essay, "Rules for very short term trades".

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

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Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.