The Volatility Trader
105 W. Monument Street
Baltimore, MD 21201
Wednesday, November 29, 2006
Email – #226
Zooming In For A “Sympathy Trade”
Dear Volatility Trader Member,
At around 3:30 this afternoon, I sent out a trade alert, advising you to “buy the AutoZone December 2006 $115 puts (AZO XC) for no more than $3.70.”
This is what I call a “sympathy trade” – one where we initiate a “sympathy position” within a stock whose sector has made such a large move that we expect other correlated stocks within the industry to follow shortly thereafter.
As you can see from the chart below, Advance Auto Parts (NYSE: AAP) took a huge hit on heavy volume today – but there was no news . However, the heavy volume is the key. Stocks don’t usually see such large volume unless something big is happening. What does this mean? Someone knows something that we (and the rest of Wall Street) don’t.
I expect the news on to surface in the next day or two – and I’ve already begun calling my contacts at the Chicago Board of Options Exchange, the NYSE, various trading desks, and different media outlets to get a hint of what might be going on here. Chances are, the news behind the selloff is out there somewhere, but it just hasn’t hit the wires yet. When I unearth it, you’ll be the first to know.
While Advance Auto Parts did sell off, AutoZone did not. Fearing AutoZone could easily take the same type of hit, investors will likely begin to exit the stock, with mutual fund and portfolio managers leading the way. And when it does fall, we’ll be in position to take quick profits from a “sympathy selloff.”
To help matters, AutoZone is expected to report earnings on the morning of Tuesday, December 5. Thus, if news surfaces regarding Advance Auto Parts that shows any signs of broader sector-related weakness, investors in AutoZone will flee the stock, in order to avoid taking a hit from a negative earnings report.
Trade Breakdown
I’m sure you noticed that, at $3.70, the December 2006 $115 puts (AZO XC) are more expensive than what we usually pay for our positions. We did this for two reasons:
- December expiration is coming up quickly on December 15, and if the stock rallies, we do not want to lose the bulk of our investment due to time decay.
- Today’s high on the stock was $113.82, which is underneath the strike price for the option. To help minimize our risk, we will put our initial closing stop at $114.03, which will help preserve our option premium, should the stock climb.
Exit is everything,
Mark Whistler
