Even after Wednesday's Federal Reserve-sparked marketwide sell-off, AppLovin remains a stock market leader. Let's consider a short iron condor trade in AppLovin stock.
With strong ratings from IBD and generally bullish sentiment in the platform dedicated to digital app development, AppLovin stock is likely attracting buyers who are waiting for opportunities to enter this name. The market backdrop this week, however, looks markedly different from weeks prior.
Why? On Wednesday, traders began to swiftly sell positions as Federal Reserve Chairman Jerome Powell took the podium during late-afternoon trading to discuss future rate cuts and what monetary policy might look like in 2025.
Until now, only shallow dips were present in AppLovin stock. We'll need to wait to see if the sellers follow through, or if traders hold their opinion about buying the dip into the end of the year and January 2025.
Wednesday's 7% bludgeoning of AppLovin stock likely got exacerbated by algorithmic trading upon the loss of near-term price-support zones. APP fell through the 21-day exponential moving average.
AppLovin Stock Today: The Setup
The recent moves in AppLovin stock add perspective to a recent suggested trade, a short iron condor in Berkshire Hathaway. Question is, do sharp price shocks bring buyers back?
When we position with short iron condors, we attempt to collect profits thanks to time decay while a stock forms bases or settles into a new direction. As always, assume that we don't know the direction of AppLovin stock. But we estimate the magnitude of the move using ATR (average true range), as measured on the monthly chart in this trade.
We also think about implied moves that market makers have priced into the trade over the months ahead.
Trade Structure
The short iron condor consists of two spreads: a short call spread and a short put spread that define a range of motion that we estimate the stock's price action will not exceed.
- Sell to open 1 APP Feb. 21-expiring call with a 350 strike price.
- Buy to open 1 APP Feb. 21 360 call.
- Sell to open 1 APP Feb. 21 250 put.
- Buy to open 1 APP Feb. 21 240 put.
The credit received is $5.60, as of recent trading, or $560 per set of calls and puts. Treat this credit as the maximum profit in this trade in AppLovin stock.
We could collect maximum profits if prices hold either below 350 or above 250 through February. In this trade, we collect a premium immediately and, as this premium erodes, we collect revenue from the position.
Our maximum risk? Calculate it in the following way: Take the distance between strikes in AppLovin stock (in this case they are both the same at $10), or $10 minus credit received ($5.60) and we get $4.40, or $440 per set of contracts.
Volatility Boost
Ordinarily, we would collect less than our maximum risk, but volatility rose more than 70% on Wednesday.
Plus, in this specific example, our probability of gains in the short iron condor with strikes further out of the money (far away from the current price of the stock) is often as much as six times more likely than the long iron condor.
Trading on the side of probabilities, rather than the possibility of outsize gains, is the way most traders who sell options operate. Put another way, they lean on the law of large numbers, which reflects what happens over a long period of time.
Defending The Trade
Now, let's identify key chart levels. Price patterns observed in AppLovin stock have been stellar. The recent fade into weekly support areas, such as 300 and 320, allow us to position along with the option traders seen as defending certain price levels of support and resistance.
I often choose option strikes that have larger trading volumes. Why? This indicates where the option traders are placing their risk parameters.
The strategy result provides three choices to exit the trade. One, buy back the iron condor once it gets to an acceptable profit margin for you. I customarily look for 30%-60% profit for these kinds of trades in the current environment of volatility.
Two, buy back the iron condor once it hits a loss threshold as determined by personal risk. I customarily look at about 65%. Yet depending on my position size, I will also choose 50%.
And three, buy back the spreads into the week before expiration, if all is going well and you have decided to hold the trade into closer to the end of expiration. However, I have had many a trade go sideways, taking it down to the wire and not capturing gains, so I do not advise this.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of "The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology." She holds no positions in the investments she writes about for IBD. You can find her on X at @AnneMarieTrades
