With the passing of Steve Jobs, the future of Apple (AAPL) is circumspect. However, it is reported that Steve Jobs left a four year roadmap for the next generation of products before his death. If true, then the fortunes of Apple appear to be in good order for the next four years, and after that, maybe not so much.
Apple’s stock price has been in an upward trend over the last two years but has been stuck in a trading range over the last four months, or so, as shown below:
With the passing of Steve Jobs, Apple’s stock price may remain in a trading range until there is some clarity with respect to Apple’s future. A potential investor in Apple’s stock could be treading water for a while.
An investment strategy to consider for a company stuck in a trading range, such as Apple, is a bull-put credit spread. A bull-put credit spread may be entered by selling one put option and purchasing a second put option with the same month of expiration at a lower strike and price. A net credit is generated from entering the trade and as long as the price of the stock is greater than the sold put option at expiration, the options will expire worthless and the investor keeps the initial net credit as profit.
Due to increased leverage, significant returns can be generated via the bull-put credit spread strategy, as well as painful losses if the stock price suddenly drops in price.
A key to successfully implementing the bull-put credit spread is managing the position when the stock price is in danger of crossing below the strike price for the sold put option. Prior to the stock price crossing below the sold put strike price, the position can often be rolled out-in-time for a net credit (i.e. additional potential profit). However, once the stock price crosses the sold put strike price, managing the position becomes problematic.
As a hypothetical example, consider entering a bull-put credit spread for Apple on 5/23/2011 with the stock price at $334.40. Prior to this, the stock had put in a double bottom in March/April and appeared to be forming a base for a leg up, so a bull-put credit at this point might have appeared attractive. A point of concern at the time would have been the second bottom (April) occurring at a lower price than the first bottom. An initial hypothetical position for consideration is shown below:
Buy-to-Open 2011 Jun 305 Put @ $1.40
Sell-to-Open 2011 Jun 310 Put @ $1.86
The prices for the options are calculated as midpoints between the bid and ask prices for the options, I’ll discuss this in more detail later. The net credit is calculated as $0.46 ($1.86-$1.40) and represents a potential profit of 10.1% calculated as:
Potential return = net credit*100/[(sold put strike – purchased put strike) – net credit]
If Apple’s stock price is greater than the $310 strike price of the sold put option at expiration in June, the return for the position is 10.1%. As a note, the bull-put credit spread should be placed with a net credit limit order, otherwise a position with less than 10.1% potential return may be executed.
For this position, a management point is set for $325 which is 5% above the $310 short strike price of the sold put option. If Apple’s stock price crosses or is in the neighborhood of $325, the position will be managed.
On 6/10/2011, the price of Apple’s stock had a low of $325.51, which was very close to the $325 management point, so management of the position was in order.
For management, the June options are rolled to July options with lower strikes. The details for the roll are shown below:
Sell-to-close 2011 Jun 305 @ $0.47
Buy-to-close 2011 Jun 310 @ $0.66
Buy-to-open 2011 Jul 295 @ $1.57
Sell-to-open 2001 Jul 300 @ $2.12
The net debit for closing the Jun options was $0.19 ($0.66-$0.57) and the net credit received for entering the new position was $0.55 ($2.12-$1.57), resulting in a total net credit for rolling of $0.36 ($0.55-$0.19) or an additional 7.9% of potential profit. With the roll, the total potential profit has been increased to 18%. As a note, when rolling, the position should be entered as a four-leg trade and with a net credit of $0.36.
An alternative option to rolling, would have been to exit the position for the net debit of $0.19 which would have resulted in a return of 5.9% instead of the initial potential return of 10.1%.
At this point, a new management point is selected at $315, once again representing a 5% margin between the stock price and the strike price of the sold put option. Once the price of the stock crosses or is near $315 management point, management of the position is in order.
On 6/20/2011, Apple’s stock price experienced a low price of $310.50, which was lower than the $315 management point, so management of the position is performed.
For management, the July options are rolled to August options with lower strikes. The details for the roll are shown below:
Sell-to-close 2011 Jul 295 @ $3.45
Buy-to-close 2011 Jul 300 @ $4.47
Buy-to-open 2011 Aug 290 @ $7.00
Sell-to-open 2001 Aug 295 @ $8.37
The net debit for closing the Jul options was $1.02 ($4.47-$3.45) and the net credit receive for entering the new position was $1.37 ($8.37-$7.00), resulting in a total net credit for rolling of $0.35 ($1.37-$1.02) or an additional 7.7% of potential profit. With this roll, the total potential profit has been increased to 25.7%.
At August expiration on August 20, 2011, the price of Apple’s stock closed at $356.03, so the August options expired worthless and a return of 25.7% could have been realized for this hypothetical trade scenario. As a comparison, an investor simply long in Apple’s stock over the same time period would have experienced a much lower return of 6.5%, although at much less risk than the bull-put credit spread.
When entering and managing spreads, a good starting point for pricing is often the mid-point between the bid and ask prices for the options, followed by determining the differential between the mid-point prices. As you can see this requires a lot of calculations to be performed. Some brokers provide mid-point pricing, but this still leaves a lot of differential prices to be calculated.
PowerOptions’ Spread Chain tool provides mid-point pricing and differential pricing which makes entering a new position and rolling to a new position very easy. With Apple’s stock price currently near its two previous support levels and near its 200 day moving average, entering a bull-put credit spread may be in order.
A bull-put credit spread for December expiration is available with a potential return of 8.7% using mid-point pricing and a margin between the stock price and sold put strike price of 7.7% as shown below:
The specific put option to sell is the December 350 with a mid-point price of $1.36 and the put option to purchase is the December 345 with mid-point price of $0.96. The net credit for entering the position is $0.40. If the price of Apple’s stock is greater than the $350 short strike price of the sold put option at option expiration on December 17, 2011, the position will return 8.7%. A management point to consider for this position is around $365. So if Apple’s stock price crosses or gets near $365, management of the position should be considered. A profit/loss graph for the bull-put credit spread is shown below:
As a note of caution, spread trades are highly leveraged and trade entry/portfolio allocation should be considered very carefully.