Last week we suggested that you should buy low Apple volatility. Having proved largely correct we should revisit our rationale. Are the reasons we outlined still valid? Have any of the fundamentals changed after a pretty tumultuous week, even by Apple’s standards?
For those who didn’t read our article we argued that volatility was a buy as:
- VXAPL, the VIX of Apple, was at a historical low of 22%; and that had previously led to a ‘mean-reverting’ increase back to around 30%;
- there were significant daily stock moves, above the amount implied in the VXAPL of 22%; and
- there were significant events coming up including the Apple/Samsung court case and, in particular, the launch of the iphone5 (probably) on 12 September.
We further suggested buying a 650 Oct12 Call and a 650 Oct12 Put, ie a straddle, for $5,560 hoping to capitalize on increasing implied volatility and any stock movement.
The position is up to around $6,350 at the time of writing but let’s sees if our reasons for the trade are still valid.
As we predicted, VXAPL (the VIX of AAPL) has risen, from 22% to 29%:
All charts courtesy of CBOE
This is now near its average of approx. 30%. IV may rise above average due to the 12 September event – but much of the ‘mean reverting’ IV adjustment (a key reason for the trade) is over. Indeed there is now downside risk as IV could fall due to the recent strong increase in the stock.
Verdict: There is some event related upside in implied volatility. However there is now downside risk, unlike when we put the trade on.
The stock price has moved from $643 to $675 pre market:
This is a significant distance from the 650 straddle, which now has a positive delta of 30. Great for today’s expected upside, but it leaves us vulnerable to any pullback.
We should expect more stock movement over the next few days as the Apple/Samsung deal is digested and we move towards 12 September. At the money (ATM) straddles are likely to rise in value due to this stock movement.
Verdict: If we are to keep the trade on we need to adjust to reduce deltas. By adjusting the straddle strike price to ATM we will do this and capture stock movement related upside.
We correctly identified the result of this case as a cause of future stock/volatility movement. Given Apple’s stunning win (at least until any appeal) this is likely to cause significant upside early this week; but then be over as a short term impact on volatility and stock price.
Verdict: This will not be a factor after a couple of days.
Iphone5 launch on 12 September
The key volatility-affecting event in the short/medium term. Most recent reports have confirmed 12 September. Our straddle has had little time to react to this date; however, as someone commented on the original article, the use of October options (to increase vega and reduce theta) reduces the effect of this date.
Verdict: This rationale is still valid but is probably not as important as we originally thought.
The only new material item of news is a potential October ipad mini launch, which may affect the IV of October options. This is, however, still uncertain and too far away to affect IV in the near term.
Verdict: There is no new material factor to affect the trade.
The trade is still valid, but not as attractive as before.
And so what will we do for our portfolio?
As ever the basis for any decision is: what trade would we put on now? If it is still the Oct 650 straddle, then don’t do anything.
In this case, there is a case for removing the trade for a nice 7 day profit, for an Oct ATM straddle (at around 675-680 depending how today goes) or even an ITM call if you believe the recent strong upwards move will continue; this also will benefit from any IV increase.
What there probably isn’t the case for is a 650 straddle.
And our choice? Well, we would probably not have put the trade on in the current circumstances – the low VXAPL in particular was a key attraction – and hence we will take our profits and move on to the next trade.
This is a difficult one given the expected stock movement and IV increase due to the events over the next couple of weeks. Those of you bolder than us may very well see significant further upside (which will really annoy those of us who sold out too early) but we are happy to count our profits and move on. Therefore we have closed the trade for $6,360, a $800 profit.
Just don’t gloat (too much) if you make more.
(A version of this article was published on Seeking Alpha)