Sunday, March 17, 2013

Sold Call Against Apple LEAP

Apple (AAPL)“surged” about 2.5% Friday to $443.  Possibly because
  • Samsung's new phone announcement did not blow away expectations.
  •  Possibly because Bill Miller was on CNBC Friday morning highlighting the low valuation of Apple especially compared to Google and Samsung. He also suggested that long dated calls in Apple might be a good strategy. Of course readers of Common Cents (see here) already know this and it did not even cost them 2 and
Whatever the reason for the gyration of Apple stock., CCI took the opportunity to sell an April $480 call for $3.45 after commissions. This short call position somewhat offsets the Jan 15 $300 call the portfolio is long. The $480 call was selected because it is slightly above technical resistance of the 50dma and just above the gap down level from the last round of earnings. (i.e. I'm thinking the stock won't get that high that fast)

A few scenarios:
  • Worse Case – As previously discussed the long LEAP is a leveraged position. Hence the biggest risk in this overall position by far is Apple stock price falling. Hopefully, Apple's low valuation minimizes the risk of that happening.  However, to try to reduce this risk, the sale of this call reduces the capital at risk in this position be 2.5% and lowers the break even point to $434 (1%). Obviously those are small changes, but every little bit helps. Further, if the stock stalls/falls from this point the opportunity to repeat this process many times before Jan 15 will exist. Hopefully, over time these small reductions in risk will add up to a reasonable risk reduction.
  • Best Case – Apple climbs back over $480 in the next month. (FYI, while I don't expect Apple to move that far that fast, that level is only 9% form here, and according to option pricing theory there is about a 1 in 3 chance of the stock touching $480 before April expiration.) As the stock climbs past $480, the profit on the trade will be capped near 30% . If this happens, CCI will be “forced” to take that profit and re-evaluate any Apple position going forward.
  • "Expected" Case – The stock trades in the mid $400s for the next month. CCI pockets all/most of this option premium and repeats the process with an option a little further out in time.

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