Investors selling Apple short are really hurting this morning. Shares of Apple (AAPL) are up +5% today after earnings beat analyst estimates. It was deeply instructive to watch trading in the days leading up to the tech behemoth's earnings report. And it actually serves as an interesting case study in trading markets.
To get a complete picture of what's happening in shares of Apple, or any asset for that matter, you need to measure and map markets across three essential factors: price, volume and volatility. Consider what happens in the panic of stock market crashes. Frantic investors rush to sell, indiscriminately unloading shares. Prices fall and the volume on stock exchanges spikes along with stock market volatility. Now contrast this with what happens in bull markets. Investors buy, volume heads higher and volatility falls.
Hedgeye CEO Keith McCullough developed his quantitative-based Daily Trading Ranges to generate dynamic trading ranges based on an asset's price, volume and volatility. Basically, at the top end of these ranges investors should consider selling. At the bottom end of the range investors should buy. Simple.
Now consider what happened ahead of Apple's earnings release. Here's McCullough discussing the pre-earnings setup for Apple in today's Early Look:
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In other words, Apple's share price was falling on decelerating volume, expressing a general lack of conviction that falling prices could continue.
At the same time, the ramp in "implied volatility" (i.e. investor expectations of future volatility implied by option markets) above historical volatility (or realized volatility) suggested investors were buying downside protection, as they always do ahead of the earnings announcement. (For more, see Chart of the Day below.)
As Hedgeye CEO Keith McCullough writes, "When a stock’s price corrects to the low-end of my risk range and prices in a lot of “protection” (options market) without a commensurate spike in volume, that tells me a lot about positioning and sentiment."
The simple answer about what it all means is that our risk ranges suggested Apple was oversold. If you held a similar view, congratulations. You're definitely a lot happier than those Apple short sellers.
