Dealing With Apple In Your Retirement Portfolio

Apr.10.12 | About: Apple Inc. (AAPL)

Every other email I receive asks about Apple (AAPL). A popular question that comes in looks something like this:

Because of Apple's strong run, it now makes up nearly 45% of my retirement fund. Could you do an article for those of us in the same boat? Should we continue to hold or should we sell? If we sell what should we put our money into. Thank you.

I guess that's a good problem to have. A #firstworldproblem maybe? Nevertheless, being overweight AAPL, or any other stock for that matter, should, at the very least, give investors a pause. I imagine that a mix of bullishness and AAPL's rapid appreciation has indeed put more than a few people in the same over-allocated boat.

That word - over-allocated - gives me a pause. It's not that I do not know what it means; rather, how do we assign value or credibility to the statement that you over-allocated in one direction or another in your portfolio? It's a game of does the ends justify the means?

If two years ago, you moved your IRA to cash and threw 100% of it into AAPL, clearly, you made the right choice. Investment advisors would have told you that you're playing with fire because you're not diversified! Big deal. It ended up working.

That's an easy assessment to make, however, when using hindsight. Fast forward to today. While it's not as if this should be presented as a triple dog dare, do you have the guts to move to 100% cash and immediately put all of that capital into AAPL at over $600? Or, if you made that or a similar move two years ago, can you stick with it and still sleep at night?

Of course, AAPL comprising 45% of your retirement portfolio is not the same as it taking up the entire thing, but you get my point. Like anything else really risky that works for a time without disaster, if you push your luck one too many times you're bound to get yourself in trouble. If you never look at your IRA, never look at a stock quote and block out all financial news for the next 5-10 years, that over-allocated AAPL position might end up losing you money.

That said, I do not see this as an either/or type situation. I do not think you have to make the decision to sell the stock or stay the course. Instead, I think it's time for investors with huge gains from an AAPL-heavy portfolio to get creative.

First, a few not-so-creative basic moves you could make:

  • Set several stop losses on your shares.
  • Sell in May and go away.
  • Sell everything else and keep that in cash.

I'm not a fan of the first two approaches. In scenario one, you'll end up selling it in stages and trimming your profits with nothing more to show for it. Plus you'll likely get shook out of the position prior to one of AAPL's many rebound rallies. In scenario two, you've packed up and gone home way before the 7th inning stretch.

I actually do not mind scenario three much, specifically, if you have a portfolio of considerable size. If you have $1,000,000 and $450,000 of it is in AAPL, it could make sense to hold $550,000 as cash or in relatively conservative investments. One prudent way to go about things would be to seek out 3 or 4 of the most relatively stable, large- and mega-cap dividend-paying stocks and spread that cash between them. Or, because you're so aggressive with AAPL, you could put that cash to work in something ultra-conservative. I could live with that.

Getting Creative With Options

The best feature of deep ITM LEAPS options might be that you can come relatively close to mimicking movement in a stock, but for a fraction of the cost.

If you own $450,000 worth of AAPL, that's about 700 shares. You could cash in your chips on the stock and purchase 7 AAPL January 2014 $400 calls for about $260 each, as of Monday's close. That comes to approximately $182,000, which is about 40% of the $450,000 you had invested in AAPL stock. If AAPL continues to soar over the next year, you will not regret your decision to swap stock for long deep ITM LEAPS calls.

Depending on your cost basis in AAPL stock, the $268,000 left over likely represents your original investment and then some. If you paid an average of $300 per share, you're taking $58,000 worth of profits off of the table and shifting the rest into long-dated options. That's one way to readjust. All of a sudden, AAPL comprises "just" 18.2% of your retirement portfolio.

Another way to go about protecting your position is to sell covered calls. You could play chicken with your shares. By that, I mean you could write close-to-the-money calls to maximize your income.

For example, the AAPL May $650 call brings in $26.25, as of Monday's close. When you write that call against your AAPL stock, you protect yourself up to $676.25. In other words, if you get your shares called away at $650, you do not start leaving profits on the table until $676.25, thanks to the premium you collected when you wrote the covered call. If AAPL pulls back, you protect yourself to the downside all the way to $623.75. You do not lose money on this trade until AAPL trades below that level.

Another way to put covered calls to work is to stagger your strike prices or expiration months. For instance, you could write 7 separate calls against 700 shares, each with a higher strike price, but in the same month starting slightly OTM. Or you could select the same strike and write one call for each of the next seven available months. Alternatively, you could combine the two strategies.

Whatever you decide to do, I hope you'll take two primary points away from this article:

  • It's never a bad decision to take profits; and
  • if you're at a crossroads with a significant stake in AAPL, you do not have to get out of the game completely. You have plenty of options.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.