Monday, February 06, 2006

Knife Catcher's Hell

The trading story of the day was clearly in AAPL today. Knife catching was a highly unprofitable business today in this stock. Shorting on the other hand, was quite nice. This is an ugly looking security right now. The uptick around 3:30 might be confused with support; in reality it is pretty much just the shorts covering prior to close so they can sleep easy.

This is the chart of a complete selling crescendo in a momo stock. Probably lots of sector rotation out to materials and energy going on right now. I am also sure, judging by the volume, that the algorithmic traders were running full tilt today, and there was a lot of money made there.

The individual buy the dippers contributed an awful lot of money as the market makers hunted down stops like crazy.

The biggest thing on my mind with AAPL is the fact that options max pain is in the low 70's. I wouldn't be surprised to see a big time bounce in this stock in time for Friday's session (options expiration). Here's why:

Now suppose I was a market maker with unlimited resources and a lot of put options in my pocket? What would I do a few days before opts ex? Take the stock down big time, sell my puts for a BIG BIG profit (for example the most heavily traded put in the Feb-06 chain was the 65 put, up 237% today). Then use profits to buy Feb-06 in the money calls at a deep discount (most heavily traded Feb-06 call was the 70 call which traded down 61%). Then let the market rise to the max pain price to limit options payouts. Now the holes in this discussion are NOBODY has the resources to do what happened today; the best you as a market maker can do is hope to trigger something. The other hole is that if I were the market maker in this scenario, I'd be buying the ITM calls such as the 62.50 and 65, not the 70 calls. But the surprising thing is that the 70 calls traded for a full $1.35, which seems to suggest the options market expects a jump in AAPL (67.30+1.35=68.65). One would expect these options to be virtually worthless with the stock nearly 3 points off the strike price 4 days prior to expiration.

Today it appears that AAPL was the battleground for players who trade on a whole different level than the average individual investor. But it is a good case study to think about the various things affecting stock trading in a security you might have bought and sold today.


At 4:07 PM, Anonymous Anonymous said...

while I agree largely with your analysis (and also did a shitty job trading this) you are incorrect about the option expiration - it is 10 days not 4 days away

At 11:45 PM, Blogger Edge Trader said...

I stand corrected - I think the overall gist of it is unchanged, though - the options market still attaches value to 70 calls. The tape doesn't lie, and it had several things to say today.

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