While the broad markets powered higher almost every day last week, underneath the surface, numerous stocks digested recent gains by consolidating or pulling back in price. In some cases, these mild corrections are setting up appealing entry points for stocks that were previously too extended.
While chasing overbought stocks can pay out from time to time, it’s rarely a money-winning proposition in the long run. What’s more, buying extended stocks offers a poor risk-to-reward ratio. Once the stock returns to a logical support level, that ratio improves dramatically.
This week in tech-land we finally saw Apple (NASDAQ:AAPL) catch a bid and break above a short-term resistance level. So far so good for the put spread suggested in “Make a Tactical AAPL Long Trade.” At the same time we finally saw a pullback in another popular tech stock that has followed a decisively different, more bullish path than AAPL in recent months — Google (NASDAQ:GOOG).
Click to Enlarge The search behemoth seems to have picked up the leadership torch that was dropped by AAPL when it began its death dive late last year. Since the autumn bottom carved out in November, GOOG is up 28% while AAPL is down 12%.
Traders who have been patiently waiting for a dip buying opportunity in the new tech leader will be happy to know that GOOG has developed a textbook retracement over the past two weeks. The $810-$815 zone for GOOG is a significant potential support level for three reasons:
- In a strong uptrend, the rising 20-day moving average (red line in chart) often acts as support, as it’s a gathering ground for dip-buyers.
- The $810 area was a resistance level in mid-February, setting up a clean breakout trade. With the stock now testing $810 from the topside, prior resistance could very well turn into new support.
- The trendline that has been in place since the November low also lines up nicely with the $810-$815 area.
Unlike the CBOE Volatility Index (CBOE:VIX), which is near multi-year lows, implied volatility on GOOG options has increased over the past month, from 16% to 24%. The uptick in implied volatility makes option-selling strategies more alluring for GOOG compared to a lot of other stocks right now.
Traders looking for GOOG to bounce off the current support level and continue its uptrend could sell the April 750-740 bull put spread for $1.10 or better. The max reward is limited to the initial $1.10 credit received at trade entry and will be captured as long as GOOG remains above $750 by the April 20 expiration.
The max risk is limited to the distance between strikes minus the net credit, or $8.90. To limit the risk, however, you could exit the spread if GOOG falls to $750.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.