Apple has been on a tear lately, up over 6% from its closing price on Monday February 23. Judging by Tuesday's price action, I believe it may head a bit lower in the following sessions, and I have outlined an option strategy to capture a move lower below. First I must mention that I do not mind owning shares of Apple after options expiration, because the strategy outlined below does involve being naked one contract of Apple (NASDAQ:AAPL), this means for each contract I am "naked" I could get 100 shares of Apple "put" to me.
Click chart to enlarge
As we can see from the chart above, Apple gapped higher to $209.93 per share at the open Tuesday and closed below that price at $208.85, finishing the day down 0.14 points (14 cents). The volume was not huge, but greater than the previous two trading sessions. I believe Apple is heading lower short term based on this bearish looking pattern, but for confirmation I need to see Apple close lower on at least average volume Wednesday.
Apple Ratio Put Spread Option Strategy: With this pattern emerging, I decided to structure a ratio put spread on Apple. This is a fairly simple trade and only involves two different option legs for the same expiration. I first must state that I only anticipate short term weakness on Apple down to the 20 or 50 day moving averages before it consolidates and moves higher. With my short term price target being near $200 per share and the stock trading near $209 per share, that gives me all the info I'll need to structure this trade.
First I purchased in-the-money March 210 strike put option contracts on Apple, then for each one (1) I purchased, I sold two (2) March 200 strike put options against them. I was able to open this spread for a net debit of $170 per ratio put spread. Using current market data as of close Tuesday the theoretical price for opening one of these spreads is roughly $195 per spread, which gives an extrinsic option premium to this spread of $80. Once opened it is very important to be monitoring this position, as I rarely wait until expiration day to close or let the position exercise, so a key support level to watch is $205. If Apple tests support near $205 per share and holds, I will look to be exiting this position, if it cannot hold the $205 level I will continue to hold it.
Profit & Loss: Although I rarely wait until expiration to get out of my positions, I will outline the maximum profit and losses associated with this trade if I waited until March options expiration to close or get exercised on this position. Assuming I could open this option position for the prices outlined above, my maximum risk is limited to $195 per spread, this will occur if Apple trades higher and closes on March options expiration at or above $210 per share. This position will achieve maximum profitability if Apple closes exactly at $200 per share on March options expiration, returning 513% or $805 profit per option spread.
This strategy has two break even points, one being Apple at $208.05 per share, and the other at $195.98 per share at expiration (less any commissions). Anything below $195.98 per share at expiration will result in an unrealized loss on shares of Apple (assuming the position is not closed and is exercised). It is important to note the net delta, gamma, and theta for this strategy as well, considering it may be a good idea to trade out of this spread before expiration. Based on current market data some important Greeks to note for this spread are Delta = -0.082, Gamma = 0.014, and Theta = -0.077.
This should not be considered if you think the stock will rally in the near future. However if you feel the stock could move lower but no lower than 4.23% in the near future, this strategy could yield a nice gain.
These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.
The reason option volumes have surged in the last five years is because they are a great way to hedge your portfolio as well as create income off of your shares (see chart here). Keep in mind when using this strategy it is essential that broker commissions are low enough to profit from the position.
Disclosure: Disclosure: Long AAPL March 210 Put Options, Short AAPL March 200 Put Options