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AAPL – The Greatest Short On Earth

 February 21, 2013 02:48 PM

There are so many reasons to sell Apple short that it would take me a few pages just to list them all. I agree with the public heads and believe, as a consumer and market analyst, their complete infatuation with the company is ultimately justified. However as a professional fund manager, there is this tactical concept professional traders refer to as contrarian investing. It's most often accurate when it feels like you're stepping in front of a freight train and almost everyone you tell either thinks you're stupid or a out of your mind. When I get either of those, I know my probability of being right on trade just shot up exponentially. I tell everyone that thinks they know something about trading but my personal opinion is they only think they know and act and talk a big game, but in reality, they're closet losers and rarely pull a dime out of the market yet always talk like they're George Soros or Stevie Cohen. Those are the unfortunate fools I love to take money from, and they're usually on the other side of most of my trades. If the general consensus is exactly opposite of what I'm thinking, I'll go all-in. The more wanna-be traders that disagree with me, the bigger my position. Simple as that.

[Related -Sobering Quarter and Guidance for Long-Time Apple Bull]

There's just way too much optimism built into Apple (AAPL), therefore, I believe the market has simply run out of buyers. In the greater fool theory which we refer to as the stock market, there comes a point when the last man standing is the one with the least patience and highest propensity to freak out because their lack of discipline is what held them back for so long until they couldn't take watching the stock run several hundred points after buying it around $100 and selling for $150, then watching it fly another $300. Even better are the fools that bought at $350 and got shaken out at $340, not realizing a $10 loss is the same as losing $1 on a $35 stock. If your stop on a $35 trade is $1 but your target is $5, then you're risk is way too tight. Just because you add a zero makes no difference to the discipline and tactics of the trade. But for the laymen that get themselves involved in stocks way over their head, a $10 loss is a $10 loss, whereas to hedgies that same $10 is a fraction of the $70-$100 they expect to make on the trade, so we actually keep buying as it goes down, legging into our trade like every other trade until we're positioned at an average price that we're content with and hold the size that we were aiming for.

[Related -What does Istanbul have to do with AAPL?]

Now, combine this with a well known fact that major round numbers are natural areas for significant reversal due to nothing but psychological reasons, which feed the behavioral finance merry go round. As such,these few facts alone are compelling enough to build up a short position around $500, but to do it slowly and patiently because there's going to be a lot of volatility right now just like there was on Wednesday when the stock ranged $35 and $19 on Thursday. But as big as the latter number looks, move the decimal one place to the left and a $1.90 range is nothing for a $50 stock. $3.50 however is 7%, which is enough to get one's attention.  However, I'm not to keen on building a large line on a $500 stock by selling the common short and then having to pay a bounty for a partial hedge unless I found a pair to buy against Apple. Can I buy Exxon since they're the same price? Since they have extremely different greeks, the ratio would be difficult to manage because it's not a sector pair. What stock can I find in Apple's sector to buy against an Apple short? The only answer is Google, but that's beyond stupid because a major sell-off in Apple will hit the Nasdaq pretty hard which will bring in the index arbitrageurs who will be heavily selling Google as well as other high flying tech stocks. So how does one approach this trade without putting $2mm up for a 4000 share short?  Obviously, I'm going to use derivatives as well as the common as well as some lower priced, undervalued stocks in the same sector that I can get long to neutralize some of the market beta because the objective is obviously to capture pure alpha only. Otherwise, why trade  Apple at all? I'd just short the SPY's.  The way I'm looking to play this is by using derivatives. Both SSF's as well as options; the most basic of which involves buying d.o.t.m. puts to make sure I've got the all mighty black swan angle covered. But that's the smallest component of the trade. The majority will involve using bracket strategies, whose names and particulars I can't (won't) disclose because I'd be hurting myself until after I've put on the entire trade. Then I can share the specifics with the world.

The company's float has expanded so much recently as a result of employee stock option exercises that have made hundreds if not thousands of employees new millionaires because Steve Jobs, rest his soul, repriced everyone's then underwater stock options which are now worth fortunes to even the janitors and the company's secretarial staff. The treasurer has to get in there and sterilize all that extra stock which adds up to over 100 million shares, before an artificially expanded outstanding float will cause an unexpected earnings dilution. Most headline numbers won't factor out exercised options which is why companies are constantly making negative comments following major sustained rallies. The goal being to knock the price down after there's been a collective exercising of vested options now trading as common stock in the open market thereby increasing the number of shares and thus diluting E.P.S.  Corporate Treasuries are the best market timers in their own stock and all but Exxon actually buy their stock back to retire the shares, whereas Exxon plays investor and rather than retiring shares bought by the Treasury, they hold the shares for use as currency to buy other strategic assets. A very tax efficient way of doing things for the worlds largest "asset based" company, versus Apple's "concept based" valuation and expectations of continued earnings growth acceleration.

Enough of the lesson on corporate behavior. Let's get back to how to play this screaming sell signal. I'm first looking for any gap to the upside on Friday morning or a rally into the prior 2 day range between Friday and Monday, with a stop above Wednesday's high. The action over the prior two trading sessions is compellingly bearish if you'd been watching and understand how to read the tape. The highest volume in over 2 years accompanied by a massive bearish engulfing bar with a nasty fuse and a 3-day blow-off top that saw the stock hit $530 before massive, non-stop and undisciplined selling took over and pounded the bid down to $490 before closing at $502. This, dear Capitalist, is typical action expected when a stock, after entering uncharted territory runs into a major psychological price point at a time when bullish optimism is excessive and the concept of the greater fool is inescapable.

Allow me to let you in on a little secret we employ at hedge funds. We dig deep for potential high probability short positions, not necessarily ones that have gone parabolic with the potential to run us over; but when certain caveats are present, such as a major whole number, a massive bearish engulfing bar accompanied by over a billion shares traded in 3 days, then we have a high probability, albeit high risk short set up. The 200-day SMA is at $385! The fastest SMA I use, whiCh is an 18 day is at $470!! Just below that is another important number, the 24-day EMA at $465, then empty space until $440 where the 50-day EMA sits just at the breakout gap from mid January. Then there's the gap at $430, as my mentor used to say, "look to the left for open air". Although I can't believe this person was my mentor because he's actually the sloppiest, least disciplined and most dishonest trader I had the misfortune of learning from, but I'm the type that always find the good in things, so I can't complain.

Again, because the stock is over $500 I'm using derivatives. Not necessarily simple puts, although I will buy deep out-of-the-money puts as a mandatory black swan trade. The real position will be a bracket trade to control my overall risk while still leaving massive amounts of profits to be gained as the stock is multiple sigma away from all of major simple and exponential moving averages. How else does a quant look for price points as both resistance in uncharted territory (besides the layman's round number theory) as well as support targets on pullbacks (again, without the layman's simple Fibonacci Retracement grid, which is foolish)? By using a multitude of data sets to see if you find convergence points where multiple projection points end up using those data sets. Without giving you my mother's secret recipe, let me just tell you a huge, whopping, Mt. Everest size convergence zone is sitting near $470, then $450, $430 and almost every $10 once below $430 all the way down to $380. Because of these factors, there are multiple option strategies to deploy, each with varying time horizons and each designed for particular price action. I'm much more comfortable with multiple brackets with limited profit as well as pre-defined risk than a naked short outright on a stock likely to announce a split of some kind soon. I wish I could bust out the details of the trades, but that would be tantamount to pure stupidity so that part will have to wait until after the positions are established for those of you just looking to learn. Those that trade options already know what needs to be done, one of them is named after a bird while a few have huge commission costs if you use retail firms charging more than $3 for each side. I've just told you two of the trades, but there are many more.



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