AM: Markets flat and AAPL up ahead of earnings

S&P500 daily at 1:20 EST

AM Update

The S&P500 is flat and digesting recent gains.  We will watch this afternoon’s trade to see if the patter of late strength continues.  AAPL is trading higher ahead of earnings, but no matter how confident you are, always mange the risk in any given trade so you will always live to fight another day.

MARKET BEHAVIOR

Stocks are flat this morning as we digest recent gains and a pause here is healthy and supportive of current levels.  We will watch through the close to see if the trend of strong finishes continues.  We are close to 1500 and often the market is drawn to levels everyone is watching.

MARKET SENTIMENT

Tech stocks are doing well after strong earnings from bellwethers like GOOG and IBM, but the eight-hundred pound gorilla is AAPL reporting after the close.  With most of the macro-economic worries falling off the front page, earnings are getting more visibility than they have seen in a long time, but is this enough to keep the rally going?

The market is within 10-points of  1500, a major psychological milestone.  While round numbers are secondary for direct supply and demand, breaking through and holding 1500 will be a psychological boost for the market and help get sideline-watchers back in the market.  But more importantly, will these be the last buyers before demand dries up, or will this finally break the dam and flood the market with new buyers?

The dynamic between bears and bulls seems fairly balanced.  Bears are still bringing up old headlines and too-far, too-fast, but bulls are emboldened by the recent gains and everyone loves being on the winning side.  When everything is equal, you have to side with the trend, but just realize every day brings us closer to the inevitable pullback.

The expected pullback is nothing more than that, a pullback.   Retesting support will provide a reality check for the market and keep the rally fresh and sustainable.  People who claim a massive selloff is ahead are not paying attention and too hung up on dire headlines that the market already digested and discounted.  The market can crash at any time, but it won’t be because of the things everyone is already talking about.

TRADING OPPORTUNITIES

Expected Outcome:
We will most likely run into resistance at 1500, but how we trade after that will determine the market’s next move.  If the market peaks and reverses from 1500, then expect a retest of recent support.  1470 was a significant resistance level could provide support for a pullback.   We could also see sideways trade at 1500, which is supportive of a continuation.  If the market surges through 1500, that is the harder trade.  It might not be a sustainable, but often these things go further and longer than anyone expects and it is hard to watch the market race ahead without us.

Alternate Outcome:
Most people are talking about too-far, too-fast and expecting a pullback, including myself, but that alone is reason enough to wonder if we might not pullback at all.  This is what we saw in Q1 of last year and this year’s Q1 could be the sequel.  This is the reason I will watch the market for supportive price action that shows this rally has legs.  I don’t want to force a trade here because we are vulnerable to a pullback, but risk is a part of trading and I will keep waiting for the right entry point.   The best way to describe my attitude to the market is short-term cautious, long-term bullish so I need to keep looking for a place to get back in the indexes.

AAPL daily at 1:20 EST

INDIVIDUAL STOCKS

AAPL is modestly higher just hours from earnings.  The options market is still predicting a 7% move.  To calculate this, add together the at-the-money weekly call and put, approximately $17.50 each, then divide by the stock price.  ($17.50 + $17.50) / $510 = 6.9%.  For those that are familiar with sports betting, this market equivalent of the over/under.

Remember we want to limit our risk in any one trade to 3% of our account value.  3% is not a stop-loss or position size, but the size of loss we are willing to take on an individual trade relative to our account size.  If you have a $100k account size, you don’t want to lose more than $3k on any individual trade.  If 7% is the expected loss, 7% * investment = $3k.  Using a little algebra we come up with $3k/7% = $43k initial investment to achieve a 3% risk profile for an AAPL trade.

This isn’t to say 7% is the most you can lose on AAPL if earnings are downright horrible, but it is a reasonable approximation.  And more often than not, the actual result will fall within the predicted 7% range because of the concept of limited gain, unlimited risk associated with selling options.  This means the options market tends to error on the high-side when coming up with their over/under to account for this unlimited risk of an outlier event.

Stay safe