Did you buy Apple (NASDAQ:AAPL) at all time high?
How fast thing change!
Only 3 months ago, financial media was full of predictions about AAPL going to $1,000 in no time. The stock seemed unstoppable. If you were reading all those stories, you would think that you are missing the train. On September 21, you finally decided to pull the trigger and buy a 100 shares of the America's Darling at all time high of $705.
Today you are down 17k. That's a 25% loss. To get back to even, you need the stock to rise over 33%. Yes, that's the sad math that many people forget - to recover from the 33% loss, you need the stock to rise 50%. To recover from the 50% loss, you need a 100% gain. The deeper the hole, the harder the climb back.
What to do now?
There are several things you can do to recover that loss.
- Just continue holding the shares. Like mentioned, from the current price of $530, you need the stock to rise 33% to get back to even.
- Buy more shares. Some will say they are extremely undervalued now, others will argue it is throwing good money after bad.
- Write Naked Puts on AAPL. That's not a bad thing to do as long as you understand that by doing this, you are effectively increasing your exposure to the stock. In addition, there are heavy margin requirements for naked puts. Each naked put will require around 20k in margin.
- Write covered calls against the stock. You will bring some additional income, but the chances to recover the loss are not great.
Can we do better?
There might be a better way. It is called Stock Repair Strategy. The strategy involves buying a 2:1 ratio call spread. Let's see how it works in the case of AAPL. The possible trade is:
- Buy 1 AAPL July 2013 545 calls.
- Sell 2 AAPL July 2013 620 calls.
The cost to execute this trade is zero (or very close to zero) and no additional margin is required. You are basically buying a 545/620 debit call spread and financing it by selling an additional 620 call, which is covered by the 100 shares of stock.
The P/L graph looks like this:
Now, there are 3 possible scenarios:
- The stock is under $545 by June 2013 expiration. In this case, all options expire worthless, and you are in the same situation as owning the stock only.
- The stock is between $545 and $620 by June 2013 expiration. In this case, the 545 call starts to double your gains, compared to owning the stock only.
- The stock is at $620 by June 2013 expiration. In this case, the 620 calls expire worthless. Your gain is 9k+ from the stock and an extra 7.5k from the calls. Hallelujah! You recovered all your losses. (If the stock continues rising above $620, your P/L stays the same).
Where is the catch?
There is always a catch, isn't it?
The main advantage of this strategy is that no additional capital is required. Of course, like with every strategy, there are some disadvantages. The main disadvantage is that if the stock recovers strongly, you don't participate in any further gains. If the stock is above $700 by June expiration, you better just own the stock. Another catch is that if the stock goes above $620 quickly, you still need to wait till June to realize the full value of the spread.
There are no free lunches, right?