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Apple Options
The Smart Profits Report: Issue #386
Friday, January 12, 2007
Apple Options: Selling Naked AAPL Put Options is the Way to Invest in Apple
By Lee Lowell
Futures Options & Commodities Specialist, Mt. Vernon Research
Boy, Apple (Nasdaq: AAPL) sure knows how to add some excitement to the market. The stock has enjoyed a $20 surge over the past two weeks - with $10 of that coming in just the last two days alone. So what gives? There are two reasons for the move…
The most obvious one is Apple’s major new product announcement - the revolutionary iPhone. This one gadget will “transform” the digital age, combining a phone, music, TV, computer, and movies. Despite Cisco currently suing Apple over a trademark infringement, AAPL shares were sent soaring.
Apple is also recovering from a December selloff when it got embroiled in an options backdating scandal. Backdating is where options are issued retroactively so recipients get the best price, thus increasing profits. It’s not illegal, but cases must be disclosed.
But Apple missed its 10-K report filing deadline amid accounting discrepancies over backdated payments to employees between 1997 and 2002. This followed the resignation of former Apple CFO Fred Anderson in October. In addition, it’s alleged that “… in a few instances, CEO Steve Jobs was aware that favorable grant dates had been selected, but he did not receive or otherwise benefit from these grants and was unaware of the accounting implications” of backdating.
But I believe the news isn’t as bad as many were led to believe - hence the late December rise. But the question is: What is the best way to invest in Apple options? Let’s find out…
The Sophisticated Way To Play Apple’s Rise
If you’re a regular investor, and wanted to buy AAPL between $70 and $75 (which looked likely at the end of December), you’re out of luck - at least for now.
But, if you’re a savvier investor, you could have executed one of my favorite option trading techniques: Selling naked put options.
Take a look at the chart below, and let’s see how it works…
On December 27, AAPL experienced a big move down to $77 per share. At the time, it looked like shares were going to keep tanking. My buy point was down near the yellow 200-day moving average line you see on the chart. That was my limit buy price.
But instead of placing a limit buy order in my trading account, then hanging around like most ordinary stock investors, hoping that AAPL would come down to my level, I got proactive and tried to earn some money while waiting. So I decided to sell an AAPL February 2007 $70 put option for $2.50.
By selling a AAPL put option for $2.50, someone would pay me $250 per option contract today in exchange for the opportunity to have me buy AAPL for $70 per share.
Wait a second… someone will pay me cash today, so I can potentially buy AAPL at my preferred price. How cool is that? Let me break down the deal for you here…
Picking Apple From The Profit Tree: From $2 To $0.10 In 10 Trading Days
Below is a chart that shows the performance of the AAPL February 2007 $70 puts over the past few weeks.
As you can see, it raced to its high of $2 per option on December 27 (at the same time the underlying shares were tanking) and has never traded higher than that.
Today, it’s worth a measly $0.10. So much for me getting filled (for now). Had I tried to sell the AAPL put option at $2 instead of $2.50, I might be sitting on some extra cash. But although I didn’t get filled on the option and the opportunity to buy AAPL at $70, neither did anyone else.
How To Beat Stock Buyers… Even If A Trade Goes Against You
When you sell a put option, you’re giving the option buyer a guarantee that you will buy that stock from him at the stated strike price if it’s beneficial to him.
So in our example, had AAPL shares got crushed and traded down to $60, the put option buyer would require us (the option seller) to buy AAPL at $70 per share, giving us a $10 paper loss on the trade. Sounds ugly… but that would be fine for two reasons:
We wanted to buy AAPL at our limit price of $70 per share and would be happy about it.
If we were starting to re-think the trade, we could always buy back the option and offset the trade. Depending on where AAPL stock is at the time, this could produce a gain or loss.
In order to be able to buy the stock at our preferred level (the strike price), AAPL would not only have to go below $70 per share, but also stay below $70 through expiration for the option buyer to come knocking.
Many times a stock will go below the strike price, giving you a sense of hope that you will get to buy it. But by the time option expiration rolls around, the stock has traded back above the strike price. If this scenario occurs, the option will expire worthless and you won’t get to buy the stock.
But in either case, you’ll always get to keep the option premium that the buyer paid you. That’s your consolation prize for waiting to see what AAPL does. On the other hand, all those regular stock buyers who had limit buy orders placed never received an option premium because they didn’t sell any options. You come out ahead regardless.
Go Naked And Collect A Premium
The reason I like to sell put options is because of the premium you can collect while you wait for your stock to come down in price. Although I wasn’t filled on my option order, it’s much better to give it a shot and try to earn some extra cash.
Selling naked put options is a viable strategy and worth your time to investigate. But remember… only execute this kind of trade on stocks you actually want to own!
Good trading,
Lee Lowell
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Today’s Smart Profits Cribsheet
- If you think a stock is headed for a decline, you might want to think twice before you take the risky decision to short it. There’s a much more cost-effective and safer way to play the down move by buying a put option instead. Investment Director Karim Rahemtulla gives you the nuts and bolts of this strategy in Smart Profits #102, Put Options: Why Short a Stock when You Can Buy a Put? 041404
- Lee’s just completed his debut book, Get Rich With Options: Four Winning Strategies Straight From The Exchange Floor - a book that could improve your overall portfolio returns 15-fold over the next year. With a record $378 billion poised to flood the exploding options market in 2007, this is the first time ever that you’ll discover the four simple secrets that institutions and floor traders are really using to earn 100-500% on each trade… while taking less risk than you’d take buying ordinary stocks. Lee’s also devoted an entire chapter on today’s topic - put selling - in the book. More information on how to own this essential guide can be found here.
- There are two ways to play a downside trend in the market. You can either take a bearish position on your long securities to protect yourself or play the downside of the market/company outright. These tactics can protect your portfolio and if you are long a stock in a number of ways. I explain two great investment strategies in Smart Profits #325, Buying Put Options & Covered Calls: Two Ways To Play A Downside Trend.
Related Articles:
- Limit Orders vs. Naked Puts: Getting Paid to Place Them On Your Favorite Stock
- Covered Calls and Puts: How to Grow Your Equity By Going Naked
- How to Use Puts and Calls: For Systematic Short-Term Profits
