It is not easy to make money in the market these days, at least with conventional investments. In my mind, the big exception involves trading options on Apple (AAPL).
I am an options nut. I have traded options virtually every day the market has been open for 30 years. I am convinced that if you can figure out whether a stock is headed in one particular direction or another, you can make extraordinary returns with options.
The problem, of course, is in finding that underlying stock or ETF whose future direction you can count on with some degree of certainty. For most of my investing years, I have used the S&P 500 tracking stock (SPY) as my preferred underlying because I only have the overall market trend to worry about. At least I am insulated from the vagaries (good news or bad) that periodically cause a company's stock to shoot wildly in one direction or the other.
Even with SPY, I have never figured out a reliable way to predict what the market will do in the short run. There is a large plateful of technological indicators to choose from, and many are right a good deal of the time. Except when they're wrong. And they are absolutely wrong at least some of the time. Since options are a leveraged investment, when you are wrong, your losses can be staggering.
I have learned not to depend on technological indicators to help make short-term option investing decisions. Instead, I assume I have no idea which way the market is headed and try to establish option positions that are neutral, at least for moderate changes in the market prices. In times when actual volatility is less than the implied volatility of options, I do very well, and when actual volatility is greater than implied volatility (as it was in June and July this year), I usually lose money.
All my investing life, I have looked for a company whose growth rate (both historical and projected) is greater than its price/earnings (p/e) ratio. Such companies are extremely hard to find. If you are lucky enough to identify one, in my opinion, you have discovered nirvana. The long-run stock price should eventually move higher. If you can feel highly confident that higher prices are likely, you can make a bundle using options.
Apple seems to be the current best idea out there. The company has consistently provided guidance that has ultimately proved to be well below actual results, sometimes ridiculously below the actual results. But even this conservative guidance indicates a growth rate that is considerably greater than AAPL's P/E ratio.
In only two of the last 35 quarters, AAPL has disappointed analyst expectations of earnings (and both times, the stock was hammered). But over these nearly nine years of announcements, the company has never failed to achieve its own guidance. So when that guidance points to a growth rate that is far greater than its P/E ratio, you have a situation when the long-term trend should be positive. In short, it is something you can bet on, at least in my opinion.
Strategy #1: Multiple Calendar Spreads: If I can find a company I feel confident is headed higher (such as AAPL), my favorite strategy is to buy calendar spreads at several different strike prices, some above and some below the stock price, but many more spreads are at strikes which are higher than the stock price. I buy monthly options with one or two months of remaining life and sell Weeklys against them.
It doesn't matter whether you use puts or calls because (contrary to what intuition would dictate), the risk profile graph is identical for both puts and calls - with calendar spreads, the strike price is the only variable that determines whether the spread is bullish or bearish. Usually, I use puts for calendar spreads for strikes below the stock price and calls for calendar spreads for strikes above the stock price, but that is because it is easier to roll out of one Weekly option and into the next week with out-of-the-money options (better trade prices are usually available).
For AAPL, I usually start out the week with one calendar spread at a strike below the stock price, one at-the-money spread, and up to four calendar spreads at strikes which are $5, $10, and $15, and $20 above the stock price. If, during the week, the stock moves about $10 higher, I would close out (sell) the lowest-strike spread and replace it with a spread at a strike which is $5 higher than the highest spread I owned (and vice-versa if the stock moved lower by about $10). This makes for a lot of trading, but the results are usually worth it.
These calendar spreads are almost always theta positive. In other words, the decay rate for the short Weeklys is greater than the decay rate for the long monthly options so I make money every day that the stock remains flat.
When the stock does manage to move higher, this combination of calendar spreads can deliver exceptional returns. In the last four weeks, a period of time when AAPL shot up by 13.3%, my portfolio gained 357% in value (after commissions, of course). I have written up a little report that shows every trade that I made and the actual positions that I had in the account every Friday here. It is a little tedious to read the full report (I made a total of 50 trades), but it does point out exactly how such a strategy works when the market moves higher.
Strategy #2: Long-Term Vertical Call Spreads: One very interesting fact about AAPL is that since the market meltdown in late 2008, there has not been a single six-month period of time when the price of AAPL was less at the end of the six-month period than it was at the beginning of that period. True, the stock tumbled about $100 from its high reached just after the April 2012 earnings announcement, but it has now more than recovered that entire loss and moved much higher (and we have not reached the six-month mark yet).
To repeat, for the past 3½ years, there has never been a six-month period when AAPL was lower at the end of the six months than at the beginning of that stretch. Think about that. If you could count on that pattern continuing, it would be possible to make a single option trade, wait six months, and expect to make a nice gain.
In June of this year when AAPL was trading about $575, I bought (in my family charitable trust account), a large number of vertical call spreads on AAPL. I bought AAPL 550 calls which would expire on January 18, 2013, (about 7 months away) and sold AAPL 600 calls with the same expiration date.
I paid just under $24 for the vertical spread ($2400 per contract). If, seven months later, AAPL was at any price above $600, I would be able to sell the spread at exactly $50 ($5000 per contract). If AAPL had not gone up, and was only at the current price ($575), the spread would be worth $25, and I would still make a small gain.
Of course, since that time, AAPL has moved much higher. Now I am in a position where the stock could fall by more than $60 a share between now and January 18, 2013, and I will still double my money. It's a nice feeling to have.
I have bought similar vertical spreads almost every week since that time, each time betting that AAPL will be at least slightly higher in six months than it is today, and most of the time, I could count on doubling my money if that ends up being the case.
As I write this, AAPL is trading at $663. You could buy a call vertical spread in the Feb-13 series which expire on February 13, 2013, about six months from now. If you chose the 635 strike as your long position and the 685 strike as your short position, the vertical spread would cost you just about $25 ($2500 per spread, plus commissions of about $2.50, at least at my broker). If AAPL closes at any price above $685 on February 13, you would double your money.
If AAPL is exactly where it is today ($663) on February 13, the 685 call would expire worthless and you could sell your 635 call for $28, making a small gain ($300, less commissions). One neat thing about this spread is that you place it today and just do nothing until February, and even then, if the stock is over $685, you can still do nothing, and your spread will be exercised for you by your broker, and you will have exactly $5,000 (less commissions) for each spread you placed.
Buying this vertical spread for $2,500 gives you the equivalent of 100 shares of AAPL which would cost you $66,300 to buy on the open market. The only shortcoming to the options purchase is that your gain is limited to 100%. Most people can live with that shortcoming.
If your 100 shares of stock rose by $10 (to $673), assuming you did have a spare $66,300 to invest in 100 shares of AAPL, you would gain $1,000, or about 1.5% on your money. With the options spread, you would still receive $3,800 (the difference between $673 and $635 x 100) for a gain of $1,300, or more than 50% on your investment of $2,500.
With numbers like these, it continues to surprise me that most people shun options because they are too risky. I think it is mostly a case of people just not understanding them.
I continue to love both AAPL's products and its prospects, and expect to invest even more using the above two strategies until something happens that would cause me to doubt either their products or prospects. I figure I have at least six months before that happens, probably a whole lot more.