Hot Shots: Applied "Bearish" Materials

It’s been nearly a month since I wrote rather affectionately, albeit with some caution and rules, about Applied Materials (). It’s a good thing, too… well, not the part about the Bovinus Optimus, but most definitely the emphasis on something other than just the proverbial “Buy, Buy, Buy!”… unless that represents some kind of funky strangle or straddle with a teaser attached.

The point here is that even the best drawn-out technical plans do falter, with losses being the consequence. Ultimately, it’s how we choose to lessen what could be blunt force trauma to the portfolio that makes us stronger traders. And on those occasions where fancy legwork finds the loss being even smaller than expected or perhaps even resulting in a profit despite an adverse move, then we’ve obviously paid attention to all of our options so to speak. On that note, I’d like to take a stroll down memory lane, get mugged by some Applied “Bearish” Materials, but ultimately be in position to fight financial crimes for another day and win one for the good guys.

Figure 1: Applied Materials () Daily “W” & Elliott Wave 4

Back on October 17^th, things were a bit kinder for the bulls in the market. Just removed from some record-breaking highs in the major averages, semi-giant Intel () issued a strong all-around report which helped to confirm the then existing large cap tech story. This corner paid homage to the news and bullish reaction by detailing Applied Materials () and its well-developed technical situation within the group.

The daily chart shown above shows exactly I was looking at on that day (Oct 18: Hot Shots). From a double bottom pattern low, EBOT confirmation and a breakaway gap thrown in the mix, there really wasn’t much to not like. In fact, for this market observer the only caveat added into the analysis was if traders waited to see a daily close above Bollinger and mid pivot resistance before entering the bullish-profiled stock.

As it turns out, erring on the side of caution and waiting for those last signals would have completely saved any would-be bulls. However, traders do need to realize that waiting for such confirmation can also drastically eat into returns as well. What if the confirmation candle was a rather large white (or green) candle? Well, playing by the ‘closing’ rules in that situation would be prohibitive to future wealth. On that note, let’s say a trader had been fortunate enough, well kind of, to be tracking AMAT on Oct 17 during the day and wanted to position based on evidence like that presented above. What might have helped the trader from receiving too severe of a financial blow and keeping enough in the account for a second attempt or fresh entries elsewhere?

Figure 2: January “Best Fit” Calls AMAT

At the same time that AMAT was closing so well that traders looking to position bullishly had a couple of different choices, as is typical. However, in looking to key off the size of double bottom (two months) and make good use of the TAPP zone, January options were a good place to start. Bulls could have looked at either October or November premium, but timing was a potential issue. October with just two days left was realistically problematic for even shorter-minded strategists like swing traders. November premium may have been considered for traders that are comfortable with the fore-mentioned style. One caveat would be the trader’s willingness to adjust or exit the position within a couple to several sessions and keep to the time discipline of swing positioning. With just thirty days until expiration, a lack of attention to time-based money management could otherwise result in Theta eating away at a position, even if the stock moved in the intended direction.

Without the luxury of having December on the board, the most appropriate month which also accounted for the fore-mentioned time variables of our technical tea leaves, were the January options. My choice, shown in the risk graph above, was the January 22.50 Calls for 1.05 and using three contracts for illustrative purposes. If all went according to plan, those options would perform quite strongly on a risk-to-reward basis as our upside stock objectives were met. Further, time decay wasn’t an issue as January options still sported 85 days until expiration. Finally, with an absolute dollar price of just more than a buck, implied volatility of roughly 31% was only a hair above its longer-term statistical volatility and with a soft Delta of slightly more than 44, we could feel reasonably confident mapping out and living with our maximum loss, should it be actualized.

I’ve labeled what I consider to be important points for both peeling off open risk, sometimes called “profits.” Also approached are price areas where the position looked to be somewhat victimized despite walking a secure and well-lit path to financial rewards. Beginning with potential growth in the trading account, the annotation “1^st Target” is thought important. Not only is it our expiration breakeven, which is well south of our technical target, but it also shows us that a move in AMAT to that level (prior to that particular third Friday) could result in a solid 1:1 adjustment for the position. With three contracts, if a trader sold two, the third contract would be a resultant credit position and one that might be given more leeway at that time, or not, depending on a trader’s preferences. The “TAPP Midpoint” is another upside target thought worthy of reassessing the position. Not only would solid profits, umm green risk, be open, but with hard Deltas a part of the equation and our trade expectations being met, it’s fully time to consider an adjustment or exiting strategy.

Figure 3: Applied “Bearish” Materials ()

On the less kind side of trading affairs, I’ve also included two points where the initial risk is being actualized and changing the character of the stock for the worse. “Point 1” is a simple “three day low” stop loss with a slight bit of wiggle room. The reason for possibly calling it a day at that point is that for whatever reason, our good-looking position is no longer nearly as attractive technically or financially. The second and lower stop loss is also technical and money-based. In this case, the stop is roughly 7.5% to 10.5% of stock risk, as well as AMAT breaking pattern (lateral) supports and the 200-Day moving average. Whether traders chose to use the “Most important hour of the day” per CNBC as their deal maker or an intraday towel toss, is something that needs to be discussed with your investment advisor.  

Looking to the chart shown above and the pin action in AMAT up through Wednesday’s close, we can see that the market gods were less than generous with my technical embrace of AMAT. However and more important than being right, well not entirely, surviving a financial mugging of sorts was made entirely possible. Depending on how a trader fights the fight, by using rules like those offered, a .40 to .65 cent hit was certainly a reality. Not that that’s pretty, mind you. However, that type of end result certainly falls under the well-managed variety for this line of work and during those instances where the inevitable Applied “Bearish” Materials keep us humble and on our toes.

Chris Tyler
Staff Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
Visit Chris Tyler’s Forum
 
The information offered here is based upon Christopher Tyler’s observations and strictly intended for educational purposes only, the use of which is the responsibility of the individual.