Recently I published a pair of articles with some suggestions how an IRA investor or other interested investor could build a position in Apple (AAPL) stock options with an outlay of no more than $5000 with the aim of turning that into up to $12,000 by January, 2014, without needing any large increase in the current stock price. This article, Heads You Win, Tail You Win was rather popular with the Seeking Alpha readership.
The plan, in a nutshell, was to buy a 2014 call option at the current stock price, simultaneously selling a call at a strike price $30 higher to form a bull call spread.
This would cost about $1,200 to implement, and then if the stock fell $35, we would do the same thing over again to increase our position.
Unbeknown to readers at that time, I implemented the same strategy myself so that I could report updates on the strategy in the future to see what went wrong if there were any discussion points or tweaks that would be interesting to readers.
I actually put on this trade in my own account for about $1,250 using the January 2014 $575/$605 strike prices.
Within a few days, the play was running perfectly as planned and I had lost money as the price of the stock plunged, creating an opportunity to buy again and acquire the January 2014 $535/$565 bull call spread for about $1,230.
I wrote about this in detail in another article called Apple Crumbles.
With this done, a weekend passed and then came Facebook Monday, a day on which crumbling AAPL miraculously came to life like a soufflé rising out of the ashes of the Facebook (FB) debacle and the share price raced up into the $570s.
Here's how the position looked today:
This doesn't look so great, but we need to bear in mind that these options have wide spreads, and that when we take the midpoint of the long and short options for a net quote, we get something rather different that looks like this.
So, here is the exciting news. The original $575/$605 call is now back to even Steven, and of course the $535/$560 call is going gangbusters as both legs are in the money with the stock at $570. We are on target. We have spent about $2,480 of our original $5,000 and still have half our powder dry.
We could just leave this alone, and things would be fine, but this would not make for a very interesting article or enrage buy-and-hold aficionados, so let's see how we can tinker with this.
Which of these two option spreads do we like the best? Clearly the $535/$565, because the stock only need to hold $565, which is $5 below the current price, for us to turn that $1,200 into $3,000 and make our original $5,000 into $6,800, a profit of 36%, which in itself is not too bad if we just let it stand alone.
But what about the other spread, the $575/$605? We could just sell it now and get our money back and wait for the boat to come in on the other, lower, spread. But wouldn't it be nice if we could now buy another $535/$565 spread for $1,200 and make 72% on the trade if Apple stock just holds $565 on January 2014 options expiration, a modest enough target if we are the good bulls that we are supposed to be.
Here's a way. Supposing we now sell the July 2012 $535/$525 bull PUT spread.
This means we sell the July $535 put and buy the July $530 put, so this little combo will put $273 in our pocket right away and if the stock stays over $535 on July expiration, we just keep the cash and do it again.
But if the stock goes below $530 on July expiration, are we now road kill? Not quite. The most we can lose on this spread is $1,000, but we have already trousered $276 which is more than 25% of that, so in reality the most we could lose would actually be $724, but we would have the opportunity to buy another lower strike bull call spread for only $1,200.
But if we kept hold of the original $575/$605 spread instead of selling it and the stock goes down to $530 by July 2012, we would be down about $400 on that, so nothing much is really at risk except some upside, and if the stock stays over $535, we can keep selling puts every month or two months until the cows come home or we get what we really want, not mere money, but the chance to buy another AAPL bull call spread at an even lower price.
I am ignoring transaction costs here for the sake of keeping the logic of the trade simple. I am also assuming that we remain bullish on AAPL long term.
If we can get $250 every 60 days by selling a put spread, that would be $1,500 per year and would add an annualized 30% to the returns on our original $5,000 position.
This article has introduced some more complex ideas than the two earlier articles, but hopefully will give the reader some understanding of how building a $5,000 position may require flexibility and adjustments as the story of the stock unfolds.
Either you stick to the original plan or you look to adjust and build an even stronger position when the opportunity presents itself. Two weeks ago when AAPL was at $570, who would have predicted that it would go down to $530 and back up to $570 again in such a short space of time?
Additional disclosure: I am not a professional investment adviser. I am just a guy with his own account who has picked up a few ideas along the way. This article is intended for discussion purposes only and should not be taken as investment advice.