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Jeff Pierce
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I’m a swing trader of momentum stocks with a holding period of anywhere from a few hours to a few months. I run a number of screens to locate the strongest/weakest stocks out there, using technical analysis to determine my entries and exits. Trying to calculate the intrinsic value of stocks in... More
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  • How To Buy Apple Stock For $30 Per Share

    By Chris Ebert

    For some traders Apple is underpriced yet too expensive to buy

    Apple (AAPL) has certainly been a great stock to own in 2012. Having begun the year trading near $400 a share, the price has risen some 65%, briefly topping $700 in September. At current prices, there are traders who simply cannot afford to buy the stock even if they want to do so.

    (click to enlarge)

    Even a trader with a sizable account of $100,000 might be reluctant to buy just 100 shares of Apple. At the current price per share near $670 such a purchase would require putting $67,000 of the account at risk. Taking such a risk on any one stock is certainly not advisable for most traders. Not only does it have the potential to cause huge losses, but it also greatly limits the amount of capital available for other trades.

    Options are not just for professionals

    Many individual stock traders may not realize that their broker will allow them to trade options. Sometimes it's as simple as asking. Some brokers offer instant option trading approval upon the completion of a quick online form. While the requirements vary from broker to broker, a trader with as little as $2,000 may qualify, although there may be restrictions on the type of option trades that are permitted.

    There are ways to use options that are both complicated and very risky, but there are also simple option trades that are no more risky than trading stocks. Using options as a replacement for buying stocks is not only a straightforward process, but it can sometimes be less risky than buying the stock itself.

    I want to buy 100 shares of Apple, but I am looking to purchase a call option instead of buying the shares. There are call options in October, November, December and beyond, and each of those months has dozens of different call options, all at different prices. How do I choose which one is best?

    Options have many different uses; speculation, generating income, or protecting gains to name just a few. Not all traders are using them as a replacement for buying stocks. The best option for those other purposes is not necessarily the best one to use as a replacement for buying stock. For a trader looking to buy a call option as a replacement for 100 shares of Apple stock, the "best" option is the one that will perform as closely as possible to a trade in which 100 shares of Apple stock was purchased outright.

    A needle in a haystack

    There are literally hundreds of call options to choose from on Apple, as is the case with many stocks. But there are only a few of them that are appropriate for use as a replacement for stock ownership. Finding the ones that are appropriate, not only for the intended purpose, but also for the preferences of the individual trader is a fairly straightforward process.

    It's good to be in-the-money

    Call options that change in value most closely to the change in the price of a stock are those that are in-the-money. That is, they have a strike price that is lower than the current price of the stock. For example, when Apple shares are trading at $670, call options at the $650 strike price are in-the-money. Right off the bat, half of the haystack is eliminated. Only in-the-money call options will be useful.

    The lower the strike price of the call option, the more closely its performance resembles that of the stock. A call option at the $600 strike price will track the profit and loss of the stock more closely than a call option at the $650 strike price.

    Owning a call option at the lowest possible strike price will most resemble ownership of the stock itself. However, that call option will also be the most expensive. There is also a very good chance that such a call option would be difficult or impossible to purchase at a fair price. Just like stocks, some options are popular among traders, and others are not. Generally, the further away the strike price of the option is from the current price of the stock, the fewer traders there will be.

    (click to enlarge)

    Choosing the rate of time decay

    Because the "best" call option to replace stock ownership is both expensive and difficult to trade, it becomes necessary to make a concession. The strike price of the option will need to be raised somewhat. Just how far to raise the strike price depends on the specific stock and also the preferences of the trader. Raise it too little and the option might still be too expensive or too difficult to trade. Raise it too much and the option will become subjected to excessive time decay.

    All options are subjected to some degree of time decay. That is, they tend to lose a portion of their value each day. On some options the rate can be very slow, on others it can occur quite fast. In choosing the best call option on Apple, a trader must decide on an acceptable rate of time decay. Is it worth losing $500 per week to time decay in order to control $67,000 worth of Apple stock? The decision is up to each individual trader. After all, it would take a $5 per share gain in the share price of Apple over the course of one week to offset the $500 lost to time decay on one call option.

    There is no right answer. $500 may be acceptable for one trader while it is possible that another trader might decide that $200 per week was the maximum amount of acceptable time decay.

    Converting time decay to time value

    If $200 per week is an acceptable rate of time decay, an option purchased one week before its expiration date can have a maximum of $200 in time value at the time of the purchase, or $2 per share. If it is purchased six weeks before the expiration date, it can have a maximum of $1,200 of time value, or $12 per share, because the average amount of time decay over those six weeks cannot exceed $200 per week. The same process applies to every expiration date. At six months from expiration the maximum amount of time value would be $52 per share while at one year it would be $104, and so on.

    Finding the needle

    For any expiration date, there is a very simple way to find the call option with the appropriate amount of time value: Find the put option that is trading at a price (or premium) equal to the time value being sought. The call option at that strike price will have a time value approximately equal to the premium of the put option.

    For example, if a put option at the $640 strike price has a premium of $2 per share, the call option at the $640 strike price will have a time value of $2 per share. This is not exactly true on some options, especially if the underlying stock pays a dividend, but it is not necessary to be exact. For the purposes of finding the needle in the haystack, approximation is sufficient.

    Making a list

    Starting with the nearest expiration date, and proceeding to later expiration dates, find the strike price of the call option that has the correct amount of time value that was calculated for that date.

    For example, with Apple shares trading at $670, the list might look like this:

    • October 12, 1 week away, $2 time decay per week , $2 time value, $640 strike price, $32 premium
    • October 20, 2 weeks away, $2 (avg.) time decay per week, $4 time value, $630 strike price, $41 premium
    • November 17, 6 weeks away, $2 (avg.) time decay per week, $12 time value, $615 strike price, $63 premium

    How to buy Apple stock for $30 a share

    Any of the options on the list will fit the original criteria that the trader decided was appropriate. The call option will perform in a way that causes it to have a profit or loss that is approximately the same as owning 100 shares of Apple stock, and the average weekly loss due to time decay will be $200. That is not to say every option on the list will produce identical returns. Slightly different rates of time decay may cause slightly different returns. In general though, under normal market conditions the returns will be relatively similar.

    Now the haystack has been totally eliminated, and what is left is a handful of needles from which to choose. So which of them is the best? Again it depends on the trader.

    If the November 17th options are chosen, the $63 per share premium is about twice as much as the $32 premium on the October 12th weekly options. There is a much higher risk of loss if something suddenly goes horribly wrong with Apple.

    If the weekly options are chosen, the position could require twelve trades over the course of six weeks. The call option would need to be sold the day before expiration and then the next week's call option would need to be purchased. It would also be necessary to adjust the strike price of the following week's option so that it conformed to the $2 time value that was previously deemed appropriate. That could potentially require a different strike price each week.

    Options are not magic

    While it is possible to use options to open a trade that is essentially equivalent to buying Apple stock, for $32 per share, it does not mean it is advisable. A trader with a $100,000 account would be taking on the risk of Apple shares plummeting, and the call option expiring worthless. That's a $3,200 loss in one week, or more than 3% of the total account, and while that is a higher percentage than many experienced traders will tolerate, it is not unheard-of. A trader with a $10,000 account would be risking nearly a third of the account on a single trade, on a single stock; that is well beyond the tolerance of most experienced traders.

    In-the-money call options should be purchased on Apple only by traders who were going to purchase Apple shares anyway. And the option trade should be handled the same as the stock trade.

    For example, if a trader would normally use a $10 trailing stop on Apple stock, then the call option should be sold when Apple shares reach the level of that trailing stop. If Apple shares were to climb from $670 to $700 with a $10 trailing stop, they would be sold if the price then declined to $690. If the price does decline to $690, that is the time to sell whatever call option is owned, no matter what strike price and expiration was chosen for the option, and no matter what profit or loss exists on that option.

    The preceding is a post by Christopher Ebert, who uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. He studies options daily, trades options almost exclusively, and enjoys sharing his experiences. He recently co-published the book "Show Me Your Options!"

    Related Options Posts:

    Much Needed Correction For CRUS - Now What?

    Option Indices Paint Rosy S&P Picture

    CTB Options - More Selling Could Be Healthy

    Oct 10 5:45 PM | Link | Comment!
  • Can The Markets Rally Without Apple

    It's a valid question because no one stock should really dictate the direction of the Nasdaq, even with a weighting as large as AAPL. Since we all have really short term memories it's easy to say that the Nasdaq cannot go up without Apple, but when you view the monthly chart (last one) below, but it wasn't until 2005-now that Apple has gone on a ballistic run that has catapulted it to the top of many mutual fund's holdings. That in itself could be bearish if you subscribe to the theory that when everybody is on one side of the boat then it's close to the time when something bad is about to happen.

    About the only way I see the markets rallying is if we start to see some serious sector rotation going on to pick up the slack should Apple's stock start to slump and go into some sort of a longer correction. A few days ago I thought Apple had survived it's 50 day ma test, but Friday's action seems to suggest that isn't the case as sellers resurfaced.

    There is a head/shoulder pattern forming on the 60 minute chart and my own indicators say that Apple is heading to $560 as part of a larger correction that needs to take place. The weekly chart is top heavy and nothing rises forever. We may bounce and rally up to resistance as the loyal Apple enthusiasts believe their stock is invincible….but all stocks eventually fall under their own weight and Apple has a long ways to fall.

    Even though I am suggesting Apple is about to undergo a correction, I personally would not short it. I never short strong stocks and I never buy stocks in severe downtrends. That is my preference and all traders must do what suites their personality.

    Short term we are seeing weakness in Apple which hasn't completely dragged the Nasdaq down.

    (click to enlarge)

    Last 16 months these two charts have been a mirror image.

    (click to enlarge)

    Apple's run is unsustainable.

    (click to enlarge)

    List of funds holding Apple.

    From an article in USA Today last March.

    Normally, enthusiasm for a particular stock can be worrisome: If most funds already own the stock, there may not be many more buyers lined up. And mutual funds aren't the only Apple fans: Institutions, such as pension funds, own $310 billion of Apple. The total fund industry owns $156 billion, says Morningstar. Wall Street currently values the company stock at $550 billion.

    Tags: AAPL
    Oct 10 3:29 PM | Link | Comment!
  • Much Needed Correction For CRUS – Now What?

    By Chris Ebert

    An analysis of stock options reveals that traders of Cirrus Logic (CRUS) are likely to feel strongly bullish. The analysis also shows that the stock was way overdue for a correction. The recent decline from the $45 highs of early September should go a long way to satisfy those traders who felt that Cirrus had simply risen too far, too fast.

    (click to enlarge)

    Because option premiums are based on emotions, the profitability of these trades is highly dependent on emotions as well. The profit or loss of option trades can therefore reveal the emotions of traders. If the emotions are known, the decision of when to buy or sell a stock can be made with more confidence. A study of stock options can therefore be helpful, even for traders who do not trade options or understand how they function.

    • Covered call performance reveals whether traders feel bullish or bearish
    • Long call performance reveals whether traders feel a stock is strong or weak
    • Long straddle performance reveals whether traders feel surprised

    For a complete description of the methods employed to complete the options analysis check out this recent analysis of Cooper Tire (CTB) options.

    (click to enlarge)

    Covered calls opened with a strike price that is the same as the CRUS share price (often called the at-the-money strike price), and opened a moderately long time before expiration, in this case 112 days, have returned a gain every week in 2012. The profitability of these trades occurred despite some significant corrections in the share price. When covered calls are profitable, traders tend to feel bullish. Because these trades will remain profitable unless the share price falls below $26 in the next few weeks, if that $26 level is reached it would very likely represent a significant switch to bearish sentiment.

    (click to enlarge)

    Long calls opened at-the-money, 112 days prior to expiration have also been profitable for every weekof 2012, although there were two occasions on which they only broke even. When long calls are profitable, traders tend to feel strength behind their bullish convictions. Long calls will remain profitable unless the share price declines below $32 in the next few weeks. So $32 represents a significant level where traders will begin to lose conviction in their bullishness.

    (click to enlarge)

    Long straddles opened by buying an at-the-money call option and a put option at the same strike price, 112 days prior to expiration have been highly profitable recently. These profits do not represent a normal condition, but instead reveal that the share price moved much further, much faster than most traders expected. The recent correction has returned straddles to a more normal range of profitability.

    It is quite possible that the pullback to $38 represents a sufficient correction to satisfy most traders. But further analysis of long straddles also indicates that the share price could fall as far as $32 in the next few weeks before reaching a level that would indicate the stock was due to break out of its recent trading range. If that $32 level is reached, it would likely be followed by either a re-test of the recent $45 highs, or an all-out selloff that might push the shares back below the $30 level where the previous breakout occurred this past July. So $32 is an important price to watch for, not only because the performance of long straddles suggest a possible breakout at that price, but also because the performance of long calls suggest a drop in bullish strength at that price.

    Possible option trade based on the options analysis:

    While there are many possible option trades that could be opened given the above analysis, the use of protective puts is definitely one to consider. For traders willing to take a chance on buying shares at the current $38 level, given the importance of the $32 level in marking a change in short-term sentiment, protecting those shares by buying puts at the $32 strike with the October 20 expiration is one possible strategy. Given the relatively low premium on those options, it is possible to over-protect the shares, that is to buy more than one contract for every 100 shares of stock.

    Overly Protective Put example:

    BUY 100 SHARES CRUS @ $38.00

    BUY 3 $32 OCT 20 PUTS @ $0.40

    This option trade can be thought of as a high-deductible triple-indemnity insurance policy. The high deductible applies because there is no protection for the shares unless the price falls below $32, so the insurance premium is much lower than the $2.00 per share required for a zero deductible $38 strike put option. The triple-indemnity applies because if the share price does fall below $32 the insurance benefit is then three times the amount of damage, less the deductible.

    Note: Performance of option trades is extrapolated where the necessary strike prices and expiration dates were not available in actual trading.

    The preceding is a post by Christopher Ebert, who uses his engineering background to mix and match options as a means of preserving portfolio wealth while outpacing inflation. He studies options daily, trades options almost exclusively, and enjoys sharing his experiences. He recently co-published the book "Show Me Your Options!"

    Related Options Posts:

    3D Systems Options Reveal Correction Underway

    ASML Options Analysis - Buy On Pullback

    Pfizer Stock Options Pointing To Another Rally

    Tags: CRUS
    Oct 10 3:26 PM | Link | Comment!
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