The NEXT Shorting Opportunity in AAPL

• Posted by DynamicHedge
• on October 29th, 2012

After a ~15% correction from the highs, it’s a safe time to cover if you’re short America’s favorite stock.  It’s times like these that traders like to get cocky and press bets, thinking they called the “ultimate top”, giving back gains in the process.  It’s also when everyone engages in the time honored tradition of armchair quarterbacking the move.  They’ll claim that shorting $AAPL stock was a no-brainer and sight some obvious-in-hindsight catalyst.  Fact of the matter is, if you’re bearish on the stock and didn’t catch the last move then you shouldn’t be looking back at all the money you could have made, you should be looking forward to the next potential opportunity.  Let’s take a look at what could be a catalyst for the next round of short selling.

$AAPL will be included in the Dow Jones Industrial Average — it’s not a matter of if, but when.  The Dow opened the door to tech stocks in 1997 with $HP, 1999 with $INTC, and again in 2009 with $CSCO.  It’s true that $AAPL is already a member of both the $SPX and $OEX and well-owned institutionally.  But let’s not forget that the Dow Jones Industrial Average is still the premier index in the world.  An inclusion for $AAPL would cement it as a pillar of American capitalism and potentially signal an intermediate-term high water mark in valuation.  When the Wall Street Journal editors name $AAPL to the index, pay attention.

This is a market structure play.  The last index funds and stubborn old men who don’t own it already will be will be forced to buy the stock.  Funds that follow the index purchase the stock on a limited-time-only basis so they don’t mess up their tracking (the only thing that matters to an index fund).  This short-term buying often creates an artificial premium.  Once the flurry of buying activity stops, there’s usually an air pocket below.  The air pocket is usually filled — efficient markets, and all.  By offering shares for sale short, you’re providing liquidity to a known buyer and getting paid for the risk (in a large sample).

Below, I’ve included the charts of the last 5 Dow inclusions.  The red shading indicates 5 days prior and post with the inclusion date falling in the center.  The charts show 30-day after the inclusion.  There are a number of caveats in the sample set including the fact that the many Dow index changes in the last 10 years have taken place in bear markets, meaning that the market was already favoring the downside.  I’ve been trading index changes for years and have found that success or failure in each trade is very dependent on market conditions and other variables.  If you decide to start trading them make sure you dig into the data, do your due diligence, and identify your edge beforehand.

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