After some market-neutral long/short plays for several weeks now, I figured it was time to make a long play on Apple and exploit the exorbitant prices investors are bidding options contracts at given the unprecedented market volatility (the VIX is at all time highs). As I explained recently, due to this increased "fear index", options prices are sky high compared to historical norms, so selling options (with appropriate protection) can be quite lucrative now compared to buying them. On Friday, I exercised the following trades:
Bought 100 shares APPLE (AAPL) at 94.6 = $9460 Outflow
I sold a Call with April09 Expiry 110 strike for 11.30 = $1130 Inflow
Possible Outcomes:
Immediate Option premium Income: The immediate income from selling the option is 12% over less than 6 months until expiry.
If shares remain below strike at expiry: Simply put, the total return on the strategy would be the actual return of Apple shares (positive or negative) + 12%.
If shares exceed strike at expiry: If Apple shares run, the return will be capped at the 17% runup from 96.4 to 110, plus the 12% I'm guaranteed from selling the option for a max of 29%. So, if it's a 100% bonanza for Apple, then yes, I've forfeited that opportunity for a 12% hedge.
For beginners to options, I recommend researching various plays, risks and protection further. However, just understand that there's a night and day difference between covered call options and naked options. If you don't know what they are now, stay away!
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7 COMMENTS HERE
Covered calls are a great strategy, and they are especially great for supplementing income in a larger retirement account. It allows you to even "rent" out your current holdings, generating an extra income on stocks that you already hold. Unless you have a lot of experience trading options to prove to you broker, covered calls are often the only option plays they will allow you to do in an IRA account.
Personally I don't like covered calls for a normal, cash-flow strategy. Absolutely nothing wrong with it, I'm just not real fond of it. Mainly because it's costly to enter a trade. The above mentioned trade would cost $8330 total, which is more than what I have in my account total right now. Granted you can pick cheaper stocks, but usually you need a stock above $30-40 to make covered calls work well.
I've found long strangles to be a very profitable and safe trading technique. It's a way to play pure options without being totally "naked". You have both sides covered, so you're not going to lose your shorts in one trading day if the stock moves against you. It's also much cheaper to enter a trade, allowing small traders like myself to make a safe, steady profit.
But as was mentioned in the post, if you don't understand what you're doing, don't do it! Take the time to watch and learn. An spend some time trading on paper before putting real cash into it. It's a much cheaper way to learn.
- Justin Bergen "The Night Trader"
Congrats of the SA article. As I said there, this is a good strategy in this volatile market. I own apple but bought at a much higher price, so riding it out for the long term. I do think however the new year will bring a nice run up in the stock markets and AAPL will jump by 30 to 40%.
I like the simple way you explained this strategy. I am planning to do a similr one with GE. I also took an option plan with the InBev takeover of BUD, what are your thoughts on that?
Well, for those who cited the high price of Apple shares, you may want to consider this with GE like you mentioned (likely lower premium due to lower beta), or perhaps Yahoo which is very low priced and offers a huge premium, with a more favorable ratio even, than Apple. I haven't followed the BUD play; I actually like CEDC at these levels in the beverage industry. Thanks for you comment.
To go along with what Night Trader said, instead of actual paper trades, you can open an account with OptionsXpress and do a virtal trade. This allows you to execute orders as they would occur in the market, but to do so with a virtual bank roll.
You can start out with $5000 or $50,000; it doesn't matter. You enter your orders or sell your contracts, stocks, etc and get a trading application that resembles a true working portfolio with your target securities.
I found it (and still do find it) helpful when evaluating trading strategies. The best part of this is that you aren't required to fund your OptionsXpress account in order to take advantage of the virtual portfolio. I skipped that part as they allow you to fund your real portfolio at any time.
@ bad boys drive audi
That is a good point. I wanted to add that I use Thinkorswim (TOS), and they will allow you to setup a virtual account before funding a real account. I don't know how long they let you keep it, but I virtual traded for about 30 days before funding a live account with them. It works identical to their real platform so other than a separate login it looks and feels the same.
Even though I have a funded account I still trade in my virtual account! It's a good way to try new ideas and just stay sharp. Most months I actually execute more virtual trades than real. Another plus is that TOS gives you 2 separate virtual accounts for even more flexibility and experimentation.
- Justin Bergen "The Night Trader"
Apple is up at your strike price already. A quick runup and a nice move! Can you explain one more time how it works when it goes above your strike price? does some-one have to 'buy' the call you sold yet or did someone already buy it and they are waiting to use it?
Yes, that was a quick 15% move in a couple days; no complaints there.
So, the option I sold is now worth more, so if I wanted to close out the position, while I made $1500 on the shares, I'd lose say, $700 on the runup in the option price for a net return of $800 or 8%. Basically, as an option approaches the strike price, it starts to move about 50 cents on the dollar. So, if owning 100 shares, you'll continue to make money at about half the rate you would have since the shares appreciate $100/dollar move in underlying while the option is worth an additional $50/dollar move.
Now, I'm not buying back the option at this price for a few reasons:
1) Nobody in their right mind on the other end of the option (the holder) would exercise the option at this point since it's just barely over strike and they'd be forgoing a lot of time premium.
2) I wouldn't buy it back at this expensive premium; I'd be paying over $1000 just in time premium since it's right about strike and worth well over $1000.
There is another way to play this if I want to continue to hold the shares and keep capturing premium..."move the sticks". A friend of mine coined this, but essentially, once it's a bit into the money, say, at $120, you buy back the option and then sell another at a higher strike, possibly even with a longer expiry to replace this one if a few months have elapsed in between. It's more of an art than a science because there are so many ways to play this, but "moving the sticks" allows you to continue to ride it up with premium income and downside protection.
Hope that provides some insight and ideas.
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