I am conflicted about this post. I’m saddened by Jobs’ passing. However, it is always wise to act on predictable trading opportunities…
A predictable pattern
The path of Apple’s stock price (AAPL) has followed a similar pattern each of the 3 previous times a problem with Jobs’ health has been announced. I’m going to repeat the plan I outlined previously, when Apple announced a health problem for Jobs, but with a slight change that I hope will improve return (see “the setup” below for info on the change).
The pattern is a gap down at market open, then a strong recovery, sometimes over several days. The gap down in price is an over reaction by investors to the bad news. But the selling drives the price down to a level that others see a buying opportunity. It’s likely that the stock will follow this pattern again on Thursday morning (October 6, 2011).
I think the pattern will be repeated, but perhaps not as strongly as in the past. This bad news has been expected since Jobs stepped down as CEO. And Jobs’ influence on the company has been reduced. So the price presumably includes anticipation of this event.
Here is a low-risk trade that will make money if the pattern repeats, but expose us to minimal risk if it does not.
First, we should wait for some evidence to confirm the hypothesis of market over reaction: Observe the market open. If AAPL does not gap down, our assumption is contradicted so it may not be wise to go forward. However, with this volatile market, there is a possibility that the overall market may be sharply up (or down) and mask the situation.
The thing to do is consider AAPL’s opening in comparison with QQQ. QQQ tracks the NASDAQ 100 index — a proxy for high-tech. We’re going to leverage the difference between the high-tech market as a whole versus Apple. If AAPL is proportionally down in relation to QQQ, we’re OK to proceed.
I will wait to confirm the gap down. And then wait for an upward tick or two. The last time we saw this pattern I waited too long to enter and missed the opportunity for 3% worth of return — the trade was still profitable, but would have been more profitable if I had entered earlier.
The idea is to buy an approximately equal dollar value of PSQ (the QQQ short ETF) and AAPL. PSQ and APPL will hedge each other, and thus provide a low-risk pair. We’re betting though, that AAPL will climb (abnormally) more significantly than PSQ will drop.
When to exit
We should know by noon whether the trade is working. We should see AAPL and PSQ prices converging. Follow this link to view a chart view of the situation. The time to exit is when they’ve stopped converging. I’ll be out by the end of the day at the latest.
First observe that it’s important not to enter the trade if AAPL does not gap down (in relation to QQQ). Waiting for this trigger allows us to enter the trade with some confirmation of the assumption that an over reaction to the news is in play.
The key risk is that AAPL will then continue down and not recover.
OK, I’m in!
At the open AAPL was down 1.25% and QQQ was down .13%. Just a little more than 100 basis points. Not as aggressive a difference as we’ve seen in the past. I think we’ll make between 0% and .5% on this today.
If nothing else it will stand as a test for my “low risk” claim.
I entered these positions at 9:36AM. BTW: If you’re not in already, I think it’s too late.
13 AAPL @ $376.39 = $4893.07
146 PSQ @ $33.27 = $4857.42
As of 9:52AM we’re up $30 (or 30 bps). So there was a little juice there. We’ll revisit at noon.
Getting ready to exit
Seeing 60 bps. Out at 10:50AM. Details later.
Disclosure: Tucker Balch holds AAPL.