Tuesday, February 2, 2010

Delicious AAPL

The Options Action gang had a few thoughts regarding AAPL on Friday night. To set the stage they mentioned the fundamental catalyst of a potential 4G IPhone rumoured to be released sometime in the near future. Assuming this will be a positive event boosting the stock price higher, something similar to a risk reversal was suggested for those seeking to position themselves to profit from an increase in AAPL stock price. While investors could simply buy shares of AAPL, at $200 it's a bit pricey. Hence the suggestion to use the risk reversal variant mentioned.

The idea was to buy a July 200-230 call spread for $9.60 in an effort to profit if AAPL rises toward $230 over the next few months. To "finance" purchasing the call spread you could sell the July 170 put for $10.60 bringing the net credit received for the entire trade to $1.00. Check out the risk graph:

[Source: EduTrader]

I suppose if you're bullish on AAPL, it may be a trade worth considering. One point worth elaborating on is the whole notion of "financing" the call spread by selling a naked put option. The way the whole concept is pitched is a bit misleading. While it may make a trader feel better or think they have less risk when receiving $1.00 credit as opposed to paying $9.60 debit when entering the trade, the reality is the risk is increased by selling the July 170 put, not diminished. If our sole purpose on entering a trade was to make it "cheap" so we didn't have to pay a large debit, then we'd all be selling additional downside puts to finance bullish debit trades. If you decide to take this route, you must understand there is a significant amount of downside risk and though you're receiving a credit to enter the trade, your broker will still hold aside a percentage of the stock price in margin to cover the potential risk.

Just entering the AAPL 200-230 call spread has much less risk and capital required than if you were to tack on the short 170 put. If you label the risk graph you can see the individual components of the spread much easier.

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2 comments:

Mark Wolfinger said...

I don't watch the show, but hot-shots love to make trading look so easy.

Of course selling the put is a totally different play when compared with buying the call spread.

They know that. I assume they are trying to sound as if they 'know it all.'

Tyler Craig said...

Hey Mark,

They usually do a pretty good job in reviewing the risk-reward characteristics of any strategy they review and to their credit I believe they did mentioning that one is obligating themselves to purchase stock at $170 by selling the put.

I guess my main quibble was the focus on trying to enter trades at a credit, as opposed to paying a debit- as if that somehow magically reduces the risk of the trade.