Apple Credit Spreads: Targeting 500% Return 21 comments
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Using a tried and true options method to capture upside gains in a leveraged fashion while limiting out of pocket expenses, I entered into a credit spread position with Apple (AAPL) with a January Expiration.
I've entered into credit spreads in the past with oil and long strangles with Apple before, but here's the most recent position I've entered and how it works. A credit spread is defined by wiki as:
In finance, a credit spread, or net credit spread, involves a purchase of one option and a sale of another option in the same class and expiration but different strike
prices.
I had promised myself recently that if I got the opportunity to buy Apple at 120's levels again, I would do it. After watching this stock yo-yo from 120 to 180+ multiple times, this week provided me the kick in the butt to make something happen.
I bought 2 Jan 155's and sold the Jan 175's to create the spread for a net outflow of $745.
Symbols:
Bought 2 APVAK @ 6.84 ; Sold 2 APVAO @ 3.18
How It Works:
If Apple shares continue to flounder and never reach $155 per share, all the options expire worthless and I'm out $745.
If Apple shares rally, I capture any upside gain past $155, but I'm capped at
$175, for a maximum return of 2*$2000=$4000, or better than a 500% return.
If Apple shares rocket to say, $300, it's OK, as long as I have the same number of long and short calls. I will always be at the $2000 profit per position ($20 per share spread times 100 shares leverage per contract).
Rationale:
Here are the drivers for an upward move by January:
- Most importantly, the recent decline in Apple's shares are really a result of poor general market conditions and not necessarily a result of Apple's core business. The shares have been up over $180 multiple times and they'll be there again. Apple continues to innovate and deliver new products.
- As bad as our economy gets, Americans and consumers the world around will continue to clamor for Apple's products. I bet they announce an innovative launch by winter holiday time.
- The thinking is that Apple is quite volatile with a Beta of over 2.5.
- While the market is undergoing much churn now, it is likely that by later in the year, while things may still be difficult, at least this phase of uncertainty will have concluded. Markets hate uncertainty.
- On this uncertainty topic, the presidential election will be over. I anticipate a relief rally following the election, regardless of the winner.
What could go wrong? If Google's new phone starts to outshine the iPhone, Google (GOOG) will rally and some air may be deflated from Apple's balloon. The solution? I own Google shares as well.
Valuation Update:
I entered into the position the afternoon of 9/18. By the end of trading, the stock had rallied $7 and the position's net gain is over $70 or 10%. Small potatoes for now, but in after hours, Apple's up an additional $3 and I expect follow through in tomorrow's market with an impending announcement by the Fed/Treasury on a new financial vehicle to shore up credit problems in the financial sector.
Disclosure: As of the time of publication, the author is long Google and has a long option position in Apple.
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This article has 21 comments:
Also, I purchased AAPL back in 1997 for $4.00 (post 2 x 2:1 splits)... and loving the investment more and more. I purchase more in 2008 the last time it hit $120.00 and sold them for a nice profit at $179. Now I got more at $120 again and looking for big returns.
I'm holding and trading Apple LONG. 11 Years and counting., I sold some to purchase a 2 family house.
Firstly, why is your upside capped at $175 - is this because you already had $175 Options which you sold to purchase the $155 Options (so you still see much upside but it is upside you would have seen anyway) ?
Second, if AAPL does go up to $300 and there is something about Options which ensures this is no better than AAPL going to $175, then couldn't you just exercise the Options, purchase the underlying shares and sell them straight away as need be ? Thanks in advance for any answers/explanations as I really want to understand this !!
I will sell BAC as soon as it looks like on a percentage basis AAPL will run faster than BAC and buy back AAPL but the $3,000 of AAPL it cost me between Monday and today is $35,000 you do the math:)
The rationale, risk/benefit, etc. is all correct.
To NinjaHamster, I generally just open/close the options positions instead of getting involved with holding the underlying shares. At these prices, holding 200 shares gets quite expensive. With spreads (debit or credit), the liquidity requirements are quite low since your max loss is capped.
Secondly, while this sounds all great, you're neglecting to point out that you're paying record high levels for AAPL volatility, and this current spread with only 2 contracts costs ~3 dollars per day to own at current levels. As the overall market volatility drops, AAPLs will likely do the same, lowering your profit without a move in Apple..
Not to say that this is a good or bad idea, just that options add about 4 dimensions to trading that most "everyday finance" type readers aren't ready for.
e.g. Had you instead bought just 1 of the 155s for $684 (less money in), it would be worth $1040 now.. a 52% return vs the ~40% you have now... Delta, Theta, Gamma, Vega all add up.. and it's dangerous to play without accounting for them all..
Good points on the cost, Apple is indeed expensive; highlighted the high Beta of the underlying stock. With VIX at all time highs, definitely paid a volatility premium.
If you compare Apple's PEG ratio of 1.13 with GOOG's PEG ratio of 0.73, you can see why GOOG is more attractively valued right now.
The recent selloff was due to the liquidation of all those esteemed firms on wall st and provides a great entry point into the stock. And with earnings coming up next month, this sucker might pop.
The play would be to buy $470 calls and sell $500 calls.
which means i am protected from loss all the way till apple drops to 78, at which point i can choose to go long apple.
i hedged that position by buying one strike 80, Jan 2009 puts, for around $100 (yes its expensive, but if apple tanks below $90 due to high volatility, i can sell this put and wait for recovery).
my margin requirement for above position is only $2000.
and i dont have pray for apple to go up a lot...
in this bear market...expecting on a big upside is not as fruitful as betting that this quality stock will not go another 40% down. and since i am selling premium, i earn money with each passing day.
but with government hands on intervention, my gut tells me that maybe we will start recovery in credit market....leading to recovery in mortgage/housing....le... to stock market rally.....and business expansion.
we will know for sure next week.