Apple Forges Ahead

Covered Call Opportunities and Tradeoffs

Welcome to another edition of Portfolio Digest with TheTape. This newsletter is focused on long term investment strategies using options.

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Setting the Table:

• Heading into Labor Day weekend the siren song of the summer for equity markets is again the 4500 level in SPX. Sorry to sound like a broken record. 

• The meat of the options curve has gotten smushed over the past week. Compared to the 10 day average, we see a deep “belly” in that curve, with the wings maintaining slightly more of their value. Implied vol at the 10 day level of only about 10% is several clicks below realized 10 day vol (13.5%).

  

• A truism about markets is that things never stop changing. What worked yesterday won’t necessarily work tomorrow. As interest rates stabilize, we’re starting to see a return to a traditional dynamic in markets that had been “broken” for the last two decades. The Wall Street Journal digs into the new correlation between stock and bond yields moving in opposite directions. 

Identify:

• About a month ago Apple released a less than stellar earnings report and proceeded to fall 13% from it’s all time highs over the next several days. We’ve now rallied back to within 4% of those highs. Despite AAPL and the NASDAQ notching their first red month after 5 straight bull market months, investors both individual and institutional are still enthusiastic about this three trillion dollar company. 

• Over the past 180 days AAPL is the highest ranked equity in the LIQ index. It shares the esteemed company of the top ETFs; SPY, IWM, QQQ, and GLD. What’s more is the variation in LIQ is relatively low. For a mean of 137, it saw a standard deviation of only 38 points. While SPY notches an impressive value of 425 over this period, the standard deviation was 180, about 50% more in normalized terms.

  

• All of this makes execution in AAPL easy. As you can see above in the LIQ chart, a significant component is the market width here. Many of the OTM options within 30 days of expiration are only one or two pennies wide. The average size in these markets yesterday was about 280 contracts up. That’s more than enough liquidity for most strategies, and significantly more could be done if an order is demonstrated as being non-toxic. (*More on that below)

  • An interesting microstructure nuance here is that the tick size might be “punishing” AAPL on the LIQ index. Currently there’s no way to trade in less than penny increments in options classes. So if a higher dollar stock (e.g. SPY or QQQ) also has penny wide markets, they will score better because that translates to tighter implied volatility bid/ask spreads. 

  • Effectively what this means though, is that AAPL will be able to absorb more depth than the screens indicate. Consistently turning over between 900k-1M contracts, whether through electronic spread mechanisms or otherwise, pricing will be even more efficient than what seems. The robustness of the spread width is an indicator there, because we know big volume trades, and the bid/ask spread doesn’t budge. 

• Over the past year, it feels like the stock has simply gone straight up. Even with a pull back we’re up almost 50% on the year. That’s potentially an argument to take a little bit off the table from a risk allocation perspective. Talking about volatility strategies, that does make it a bit more difficult, as while AAPL is only has an implied vol at 30 days of 16% currently, there has been a strong “delta” bias to the underlying. The SPX has an implied vol of around 12% right now and it’s moved 15% on the year.