My Options Play on Apple

For some time now, I'd been employing covered calls as a means to generate income in a down/flat market. More recently, with markets rallying 60% from their lows, the Apple (AAPL) covered calls have come home to roost. For a detailed background and example of how the Apple position was structured, see How Covered Calls Work. While I've captured thousands of dollars in option premiums from my Google Credit Spreads (GOOG) and Apple covered calls over the past 2 years, it's not a free ride. You do of course forgo unlimited upside when a stock runs unabated like Apple has in recent months.

My most recent covered call position for Apple was opened during the crisis when shares were trading at $96 per share and I sold covered calls along the way as shares slowly moved upward. More recently though, shares zoomed right past 160 to over 200 as of today. As such, I had to start thinking about the exit strategy for the covered call which was well into the money.

I had two options:

1) Leave the position alone and let someone execute the option and lose my Apple shares at 160 per share: Since I owned 100 shares, whatever the share price does from here (unless it dropped back below 160 quickly), my net cash position is unchanged; the shares and the option price move virtually 1:1.

or

2) Buy back the call option (granted, at a much higher price than what I got for it initially) and do whatever I want with the underlying shares.

• I opted for #2. Why?

I didn't want my 100 shares of Apple called away without any control over the situation. Due to the wash rule I wouldn't be able to buy back shares for over 30 days and I don't want to miss out on continued upside I foresee for the stock. But since I took a hit on buying back the call (a cash hit only, offset by 1:1 paper gains in 100 AAPL shares), I sold off some of my position to take some gains on the shares as well. My portfolio allocation was way out of whack. My initial entry point for Apple was 96. With shares running up 110% since entry, Apple now comprised over 30% of my trading portfolio. That's simply too much in a single stock, even though I like its prospects.

Outcome - I ended up closing the call and selling 50 shares of Apple at $203 for a gain of over 100% on those shares. While I paid $4400 to close the call, I took in $5350 in cash from the Apple shares. I'm still holding the remaining 50 shares.

Note that there was just a wee bit of option premium left on the the open Jan 160. I intentionally waited until after this week's earnings release to allow for the volatility premium to drop out so I wasn't paying for additional premium unnecessarily. As recently as a few weeks back, the option premium was over $400; today it was closer to $100. So, I paid an extra $100 over intrinsic value for the peace of mind in closing the position out with a great overall gain. Obviously, since I sold the option initially for around $1000 my net gain on paper has still been close to $10,000 considering the capital appreciation plus the prior covered calls minus the $4000 to buy back today's call, but the only regret is I could have enjoyed a pure share gain without capping at 160. (205-96)*100 = $10,900.

Summary: I sold options when volatility was high during the crisis and got a nice upfront premium. If Apple shares hovered in the low hundreds or even up to about 160 per share, I would have kept the full premium plus gains on shares. However, since shares zoomed past the strike, I wasn't able to enjoy the gain past 160. Not a bad outcome overall - could have been worse, right? But just keep in mind with covered calls - there's no free ride.

Comments

[NDinMSP:]

Betting against Apple points to a non-existent brain.

Oct 22 07:22 AM

[Pauly B:]

There are always trade offs with every option stradgey.

You might want to think about trading double calendars on Apple 3 weeks out before earnings to capture the volatility increase prior to earnings. Get out two or 3 days before earnings and whala! You should have a nice return

Oct 22 09:23 AM

[TCK:]

Why not roll the calls into a higher strike and later date ?

Oct 22 09:33 AM

[Concerned One:]

I don't understand your comment on the wash sale. My understanding is that you cannot take a loss and recognize it if you buy back the stock in 30 days. That is a wash sale - designed to prevent you from realizing losses when you repurchase the shares in the 30 day period. You had a gain on Apple. Nothing prevents you from selling at a gain and be subject to the wash rule. Am I wrong?

Oct 22 10:14 AM

[Everyday Fi...:]

TCK- With volatility at a very low level tha value just isn't there now. I could only get another 1000 or so for another decent call but would have to cap upside pretty close and just shelled out 4k for buyback. So I opted to take a little cash out due to portfolio imbalance as well.

On Wash Sale- you're totally right. Freudian slip! I'm sitting on losses elsewhere in the portfolio and the topic is on my mind but wrt a gain, no concerns then. Thanks for pointing out!

Oct 22 11:13 AM

[Fremont Rea...:]

I don't own any Apple Shares and I bought a iPhone 3GS and returned it after 20 days, because I liked my Blackberry better for mail and phone. However most people are buying the iPhone. When I spoke to the rep at the ATT store on Monday, he said most people were buying iPhones and Blackberry sales were down.

Blackberry needs to step up its browser and app game, to increase its appeal. The new Blackberry Bold 9700 is won't be enough, it's too incremental, and will only appeal to the corporate crowd.

Oct 22 01:31 PM

[brewer:]

@ Fremont:

Did you actually try to use the iPhone during the 20 day trial you gave it? Stuff beyond simple email and phone? What didn't you like? It takes at least a week to get used to the on screen keyboard, but really it's very nearly as fast and much more advanced. For example, for any special characters, just hold the key a second, you will get a menu of all types of that character, etc... try doing that on a Blackberry.

Blackberry is good at email and phone though, just not anything else.

Oct 22 02:35 PM