First, we should note that we may be executing our Stock Replacement Strategy any day now. We believe AAPL & the overall market has one more flush to the downside that we should see this Monday morning, or within the week that will be short-lived. Inversely, it's important to consider that since AAPL & the overall markets are all sitting at a 30-RSI on the daily this area has more often than not been a very strong area to bounce. So we may see a gap up that gets sold off, or we may see a bounce that lasts all week long. What's important is to observe the quality of the rebound or plunge for that matter. If we get a a strong bounce we may still get long on the call-spread. Our ideal setup is for AAPL to 1) ideally plunge or 2) fade lower off a gap-up. Again, the quality of the bounce will matter. We'll explain why it may be better to wait since we usually a bounce here would still be retested lower / sold-off in the near term. Vertical V bottom recoveries like we saw post Brexit are actually very rare. But that's why we're long either way. So our upside hedge is in play because we are already long.
The result of how this sell-off or bounce develops will dictate which call-spread we enter. In gist, if we plunge lower or fade a gap up, then we will take a more aggressive, higher yielding spread. Whereas if the bounce is starting effective Monday morning, then we'll get into a slightly more conservative call-spread. In either scenario, they will both be conservative - we're just making the distinction that one will be more conservative than the other.
Furthermore, it's important to distinguish that nothing has changed in the big picture forecast. We still believe that AAPL & the SPY will see all time new highs in the primary term trend. We are still very much in a bull market. There will be periods where it doesn't feel like a bull market, but so far when we look back at history, all those were merely intermediate term & near term bearish cycles, the primary term has still proven to be trending higher.
On to our Stock Replacement Strategy, we've tabled several call-spread options - some for more aggressive investors and some for more conservative investors. To view a dynamic version of this table where the "Current Ask" column is being updated in real-time, please click here.
We're either going to rotate into a 2017 November or 2018 January spread. Specifically the 110/120 Call-Spread. There are advantages to paying a little extra for the 2018 Jan spread but it will yield at a slower pace than the November spread once AAPL starts climbing again. Note* that both of these spreads are largely based on $AAPL going no where and being more in a bear market than anything. We do believe AAPL will trade much higher a year from now....but we're not going to bet our whole stock position on that thesis. For a complete refresher on what our aim here with the stock replacement strategy is about and how call spreads work please read our earlier post here → https://goo.gl/iFWRcZ
As mentioned, we suspect this Monday morning we may be executing the trade if AAPL can gap down on a plunge ...that when we will be initiating this Sell & Buy order....if we can get low enough. If it's just a small gap down in the range of a $.50 cents or so then that's not enough to trigger the buy program. We need total hysteria. Being this early in the quarter, we need either a strong & swift form of capitulation that brings AAPL down to the $107 - $104 level, something like a -$3 down day from here. Or otherwise we would wait for later in the quarter for AAPL to fluctuate within a range of going up back to $112- $115 and getting everyone all excited and then pulling back down towards the $108-$110 level, exhausting buyers and sellers in an orderly fashion, back & forth...drawing the quarter out ...as we get closer to the end of this quarter, that's where we would initiate this kind of trade. Why? Because we need to account for theta deterioration & or options volatility to meaningfully erode options premium. That's when we want in. The aim is not to catch the bottom per say, but rather to get favorable pricing. This happens nearly every quarter, we watch AAPL struggle with certain levels and then rally...all in the meantime, there are several instances where volatility &/or theta decay occurs in the options market causing a significant opportunities in the options market. The stock in many ways, is fluctuated ( in it's short term at least) at the service of the Options market. In other-words, they throw this around, keep the stock caged, plunge, rally, in spades just to milk yield in the options market. So we want to do our best to identify a golden goose position that came to us at a significant discount. They happen at the end of long drawn out periods or during extreme volatility is the point.
Again we need either-or, or a combination thereof: Volatility &/or Theta Decay.
Volatility would look like this for an entry, much of how we get our entry on the March 100/110 call spread filled at $5:
Notice the pattern of how the market has the tendency to beleaguer longs on Mondays after they've already taken a substantial beating in the prior week. One can infer that the market is devious in the short term attempting to set a bearish tone for the onset of the new week but then swiftly trend-change that sentiment after max pain has been afflicted = capitulation
Where as theta decay is best described as, for example, lets say AAPL get's back up from this level to $115 then sputters and falls back down to $109 then back up to $112 then by mid December it falls back down to $107 to scare the bejesus out of everyone, by then it's all together possible that the March 100/110 call spread could be trading @ $5 flat. Our initial entry on the March 100/110 call spread took AAPL being around $104 in early September. That's an example of how a long & drawn out quarter of AAPL being range bound can afflict option prices in regards to time-decay.
Again, so the call spread we are targeting will be one that can yield anywhere from 150% to 200% (depending on where we get filled) so long as AAPL stays above a certain conservative number. Some may want to bet on AAPL being above $110 per share one year from now on a spread that has 70% ROI so longs as AAPL is at or above that $110 target; some may want to bet on AAPL being above $130 a year from now. We will table several different spread options for your consideration but I urge you to lean towards a conservative one. We are targeting a vertical call spread that only asks AAPL to be at or above $120 within a years time. Right now we're currently considering either the November 110/120 call spread (max value achieved if AAPL gets to $120 by November of 2017) or the 2018 January 110/120 spread, or the January 100 - 120 call spread.
As of the close of Friday, the 2017 November 110/120 call spread is currently trading at $4.05 . Those same strikes for the 2018 January 110/120 call spread are trading nearly equal at $4.10. For simply $.05 cents more ($.05 x 100 since each contract is an allotment of 100 shares) you gain a pretty much a whole extra quarter. For those new members who have just joined to learn more about how call spreads work please read our original Call Spread trade here.
In gist, let's consider the 2017 November 110/120 call spread if filled at $4...and since the max value is $10 (difference between the two strikes) then the return on this investment is your $4 investment traveling to a value of $10 which is a 150% return: so long as AAPL closes at or above $120 a share by November of 2017. That's a year way. So you're betting that AAPL will close at or above $120 within a years time. Your breakeven on this spread is AAPL at $114.
In short, the idea is to sell our stock at the lows and rotate that capital into a higher yielding and very conservative call spread that will far outperform what the stock position would have done. It's critical that we distinguish that this is not a gamblers options trade where you sell your stock and put that into some kind of aggressive call/option position. The point here is to get more yield than what we can reasonably expect that stock to do on a per share basis on performance. For example, if AAPL were to get all the way down to something absurd like $100 a share this quarter, and we can sell our entire stock position at $100 a share and move that capital into a call spread where by in which AAPL would yield a 100% return so long as AAPL were to be at or above $105/share in a years time....then that is an extraordinary risk/reward opportunity. In contrast, for AAPL to make you a 100% return if you were holding just the stock then AAPL would need to travel all the way to $200 a share in years time....that is highly unlikely. We probably won't see $200 a share until sometime in 2019 - 2020. But if you could make a 100% return by only asking AAPL to simply stay above $105 by next year, well then...that's a no brainer. Just to give you a valuation idea on a Price to Earnings basis , if AAPL were trading @ $105 a share next year then it's PE would collapse to an all time historic low of around mid 7 PE. We ever only saw a sub 7 PE after the .com bubble in 2000, and as we all know AAPL was an entirely different company then pre-iPod/iPhone. So that era really doesn't have any relevance on a contextual, historical basis. The point here is this, it's highly unlikely that AAPL will be trading around a mid 7 PE next year. In fact, the lowest PE AAPL has seen was an 11 PE during the financial crisis and then even lower at a 9.52 PE during the 2012/2013 crash. See below:
Again, further supporting the case why AAPL will be trading well above $105, $110, or even $120 for that matter is that you have price action breaking out simultaneously with rising PE valuation. This is yet another piece of evidence that further reinforces the bull case.
Again, the point here is to not bet on the most bullish scenario but rather if we're going to replace our actual stock position then we want to be in a call-spread that is near the ultra conservative mark and takes into consideration what would the stock look like in a bearish environment.
Here is an example of what AAPL could do for the entire year. It's not beyond the scope of possibility by any stretch. We don't expect this will happen but if it did, then this is precisely why you want to be in a well armored, conservative call spread. See below:
If we got into a pickle where AAPL traded range bound for an entire year, then both the November & Jan spreads would afford us plenty of time to assess the risk of the pattern and allow us to get out at near the high range as a pattern like this matured. We'd most likely come out well ahead getting out near the top of the range, probably around April of 2017. If AAPL hasn't broken past $120 by March then that could signal to us to make some changes to the January 110/120 spread. So the point here is you want to pick a conservative spread that will allow you to GTF (get the fuck out of dodge) if scout for a better trade setup. Again, we don't think this is how AAPL will play out; I'm laying out an intermediate term bearish model for how that could play out.
We've updated the Spread Table so that the "CURRENT ASK" column is dynamic and showing the actual value of that spread position - this is being imported from Yahoo Finance. So although prices are current & will dynamically change, you can expect your broker's asking price to be just a tad different when you pull up the quote. To view the dynamic table please click here.
Some may want to be more aggressive or even more conservative than us, so we've updated this table with some other call-spread options for consideration.
Separate from our Stock Replacement allocation, we may buy something a little extra for the near term if we get lower than $106 this quarter. Something more like a booster that will appreciate much quicker than a November spread. The reason is very simply because we are at a 30 RSI on the daily and what we can always expect is at minimum a 12% bounce higher from the printed price of AAPL when it hits a 30 RSI. Let's discuss where AAPL is more specifically
Alright, as of the close of Friday everything is now at oversold levels on the daily chart. The SPY is down to a 29.10-RSI on the daily and a 32.75-RSI on the hourly. The hourly low intraday got as deep as 23.63-RSI which is extreme. The NASDAQ-100 is at a 30.16-RSI on the daily and at an 18.47-RSI on the hourly. Not only that, the QQQ is deeply oversold for a long period of time now. Can't be far from a bottom. Maybe we're in for a Monday capitulation. Historically Monday's are known to be where we get a deep shake out to plunge out stops before a trend reversal. What we would love to see is a deeper low here on a higher RSI reading on the hourly chart: so positive divergince is bullish...when you get lower price action relative to higher RSI, this suggests sellers are losing steam. When the market starts to lose demand for selling aggression it tends to be the perfect opportunity to shift the value proposal towards the upside. Why? Because of a lack of demand for lower prices and that's usually when you get a trend reversal as the majority gets on board for a trend change towards the counter.
So Apple hit a 30-RSI this morning and closed the day rading at a 29.73 -RSI. Remember that once Apple hits a 30-RSI in the overwhelming majority of the cases we get a 12.5% rally. In even the weaker cases we saw a 7.5% rally from low to high. Hell even though the stock was continuing in a downtrend to a 20-RSI one time and we saw the stock rebound 4% in-between on the same pull-back altering hitting 30. This was during the same sell-off. We saw it bounce for 2-days and then continue lower (same sell-off). The point is that we've now hit a point where history suggests that Apple is due for a monster rally. Take a look below:
Now here is what is interesting about Friday's session. We're already starting to see a reversal bar form. Apple formed a hollow red bar (where the close is above the open). This happening right around the 30-RSI daily is not just a coincidence. Technicians all see this and this is where a great deal of buying starts to come back in.
Here's another really encouraging sign that perhaps we're nearing a bottom. Apple is not the only one trading at a sub-20 RSI on the hourly. We're getting that across the board in the market. The NASDAQ-100 is at sub-20 and the SPY is at 25. What's more, they're both at a 30-RSI on the daily. So what that means is that a large part of this sell-off is attributed to the market. Usually when that's the case, it's even a stronger probability that we get a major rally in Apple soon.
I have done an analysis of how long it takes for Apple to bottom once it reaches a 30-RSI and the corresponding rebound. I've done an analysis which shows how many days it takes for Apple to begin its 20% rally once it reaches a 20-RSI. How many days it takes for Apple to reach its ultimate low after reaching a 20-RSI etc. These are all useful things obviously. But I do think it would be useful to know at what price level does Apple reach a 20-RSI, how may days does it generally take on a historical basis to get there once the stock hits a 30-RSI and the general percentage loss between a 30-RSI and a 20-RSI.
While it's going to take a long while for me to complete that analysis we can speculate as to how low Apple would need to go to hit a 20-RSI at this point. Remember, as it stands right now, we're in a very good place considering our March spread. Why? Because in the worst case scenario Apple would be sitting at its highs by January even if Apple underwent the worst correction that we saw in 2015. Even if Apple fell to a 20-RSI and took 5-weeks to bottom out, the stock would still be sitting at highs by January. Why? Because on a historical basis, once Apple reaches a 20-RSI, there tends to be a 20%+ rally that occurs from those levels (or around those levels). Once Apple reaches a 20-RSI, the lows from that point are only incremental. You don't get big percentage losses after hitting 20. So from that point, if you bought at a 20-RSI, you can expect a 20% rally in your favor.
So every time it did hit a 20-RSI, we got a 20%+ rally in the 2015-2016 bear market. On three occasions did we see Apple hit a 20-RSI and in all three occasions, we got a massive rally. In the August-September 2015 sell-off, Apple hit $92 a share at the reactionary lows and rallied to $117 a share in the coming weeks -- that's 27% in a just a few weeks time. The stock actually continued up to $124 before peaking after October earnings. Then we had the January segment of the crash which bottomed out in February. Apple then rallied for the month of March and part of April to go from $92 up to $113 a share or 22.8%. Then in May 2016, Apple collapsed after April earnings, hit a 20-RSI again down near the $90 level, rebounded on Berkshire to $101, fell again to $90 hitting a 30-RSI in the process and then rallied from $90 up to $118.30 before topping out again here.
So you see, even during the 2015-2016 bear market, Apple rallied 20%+ every time it hit a 20-RSI. That's why a 20-RSI is such an incredibly strong indicator. Apple is 7-for-7 on that indictor. The smallest rebound went for 18% in November 2012 when Apple rebounded from $505 up to $595. Now remember, just because Apple hit a 30-RSI here doesn't not necessarily mean we got to 20. In fact, historically speaking, Apple bottoms out in nearly half the cases upon reaching a 30-RSI (that's today). It bottoms the day of or within a couple of days in most cases. See below:
Take a look at this table above and count the number of times you see the number "1", "2" or anything below 5. That number signifies the number of days it took Apple to bottom out and begin rallying after hitting a 30-RSI. Notice how in MOST cases, we're talking the day of or within a few days. It's the extreme RARE exception for Apple to continue to fall down to a 20-RSI. Apple bottoms out at 30 or just under 30 in most cases. It then goes on a huge double-digit rally shortly thereafter.
So really the best thing that can happen to us would be Apple opening down -$2 this Monday morning and then sliding another buck or so. That would put Apple at around $105 and likely closing at 20-RSI. There's a gap that needs to be closed down at $105 a share. If Apple closed down there and at a 20-RSI on a closing basis, we would be in the best position yet. Because interesting things begin to happen once Apple reaches 20. First, the amount of time that lapses between when Apple finally hits 20 and begins to rally is actually not that long even in the extreme cases. For example, the longest Apple remained extremely oversold was when it hit a 20-RSI back in late April or early May. But when you count the days until a rally began it was only 7-8 sessions. And if you count the amount of time brexit included until we started really rallying, it was 30-session in total. But remember, the rally went for more than 30%. Apple had rallied to +20% just a few day after it reported earnings. It was really soon thereafter. A 20% rally from $88.90 is around $107 a share. Apple was beyond that point by early August. So it was a total of what? Three months until Apple had bottomed, re-tested its low and then was up 20% already. That's 3-months until the daly started. That's 3-months to go through the bottoming process, rebound 11%, fall 10% on brexit and then rally 20% up to $107+.
Now apply that to this situation. If Apple hit a 20-RSI by Monday or Tuesday, that would put Apple, again, at around +20% from those levels by the time we got to late January -- a full 2 months ahead of our March expiration. And that all makes a lot of sense really. When you think about it, the guidance was excellent. It's as if the market just completely ignored it. Apple is clearly going to deliver some very positive results. The stock wasn't rewarded. The election will be behind us. The market will be relying as it also just hit a 30-RSI. So there's a lot to suggest we're going to be sitting at around $120 a share by late regardless of the route taken. Either we get down to a 20-RSI at around $105 and close the gap and then rally 20% beyond $125 a share by January. Or we bottom out Monday-Tuesday with a strong reversal we have going and rally 12.5% or even 11% and get up there anyways. One thing that we do need to be concerned about is the small post-30 RSI rally that leads to even significantly lower lows. For that reason, it's a very small chance right now, but for that reason we may consider selling our March spread at around $115-$116 regardless of what comes next. Like think about it. Suppose Apple does only rebound 7% up to $115 a share. Right now a 7% rally from $108 is $115.56. If Apple only gets up to $115.56 or $116 a share and starts to decline again, this could look a lot like 2015 again. So there's a lot of danger in that zone. It may be smart to let that position go. The risk is very small as we're only asking AAPL to be at $110 by March. But we'll need to see AAPL trade comfortably above the $110 mark. We believe that comfort is being cultivated right now...but again we need to see it happen sooner than later.
We'll get to that if that develops. We can only trade what's in front of us. For now, we have more evidence to suggest that a big rally is underway. The important thing about how to effectively trade AAPL is to position ourselves in a well armored spread that has plenty of time and a very reasonable target.
We'll update everyone when we get there. We may be taking this trade within the first hour of market open, or mid to end of day. It just depends if we get a significant gap down and deeper RSI print relative to a reversal pattern thereof.