Welcome back to my weekly column.
The sense that the market is short term oversold and due for a pullback deepened this week in the US market as the Dow corrected down 2.95%, making a new 3 weeks low. In fact, it look like the widely anticipated pullback is now beginning with the Dow right at its 200 days moving average, which is a strong resistance guide.
Even though the US market could be in for an imminent pullback, the long term outlook remains excellent as long term bond yields reflect rising interest expectation. Many of the old time favorite stocks are favorites once again and that includes Apple Inc. trading under the symbol AAPL (bet you knew that already).
Apple launched their new iPhone 3GS last Friday with AT &T reporting better than expected sales. Like most other stocks, AAPL took a hit in this economic crisis due to multiples contraction. AAPL dropped from its high of slightly above $200 to a low of about $78 in January 2009. Even though AAPL lost more than 60% of its stock value in this economic crisis, Apple, the company, continued to make even greater revenue in financial year end 2008 versus the previous years. Yes, a beat up great company! Investors took notice early and AAPL has been rallying since Feb of this year and AAPL has since recovered almost 80% off its bottom to close $139.48 last Friday.
Again, this is a great stock in a market that looks ready to pullback.
As options traders, what can we do to make sure that we profit if AAPL continues its phenomenal rally and also if it actually went sideways or slightly down with the probable market pullback?
There is one simple options trading strategy and it is called Put Write. Put write simply means writing (or shorting in stock trading lingo) put options when you expect a stock to be moderately bullish. What put writing really means is selling a put option to someone speculating that the same stock would go down. That really sets up something of a bet but you are playing the bookmaker this time. If the stock goes up, the person who bought the put options loses and you keep the “bet”. If the stock goes down, you would have to hand out the payoff. Now the thing is this, you only lose in this bet if the stock goes below the strike price of the put options. This is why we would only write out of the money put options which returns a reasonable return and still ensure that the stock has some room to go downwards. This allows us to profit when AAPL goes up, sideways or down.
In this case, since we are writing options, we would want to sell options with as short an expiration as possible to make sure the guy at the other side of the bet has as little time on his side as possible. This means the July options. We also want to make sure that AAPL has some room to go downwards in case the market pulls back. We could take the cue from its short term support level of $130. This means writing the AAPL July130Put which was bidding for $2.36 last Friday. For every contract that you write, you make $236 in profit as long as AAPL ends up above $130 by the third Friday of July when the July options expire.
Now the only scenario where this position can lose money is when AAPL closes below $130 by expiration of the July put options. Is that really a negative? Not really! If AAPL is below $130 by expiration of the July options, the put options would be exercised and you would buy AAPL shares at $130! As an investor bullish on AAPL for the long term, holding AAPL at $130 sure makes a lot more sense than its present price of almost $140 right? What if you have no money to buy the shares? This is where margin comes in. Margin ensures that you have the money necessary to fulfill the purchase before allowing you to write the put options in the first place.
In this sense, you win no matter what. If AAPL goes up, you keep the $236 per contract written. If AAPL goes sideways, you still keep the $236 per contract written. If AAPL goes down below $130, you get to buy AAPL at $130, which is almost $10 lower than it is now, and keep it for the long term.
See why so many options gurus out there tout writing put options now? So whats the drawback? The drawback is that if AAPL turns out to be a rotten company due for bankruptcy in the near future and its stock price is ready to drop to all the way below $1, you could lose your whole investment. Do we see that coming for AAPL? Not me at least.
Read my tutorial on Writing Out Of The Money Put Options.
Let’s take a look now at our previous options plays:
DRYS continued to move within its $6 - $8 channel last week, closing at $6.19 last Friday. If you had gone on the holding on to only the Sep 11 Calls mode I talked about two weeks ago, you would have pocketed more than half of its original value in profit and probably at breakeven for the overall position. At this point, you could consider to buy back the Sep7.5Calls at its now lower price of $0.90 to continue a bullish outlook for the next quarter.
EEM retreated 5.9% this week, which continues to play to the benefit of our Call Ratio Spread. As long as EEM remains below $37 by September expiration, the position will be in for a profit.
NYX retreated slightly as we have expected and the June options written have expired out of the money nicely last Friday, totally fulfilling the purpose of the Covered Call. In terms of account value change, if you had written the June31Call, you account would be down $0.85 instead of $1.50 if you had not done the Covered Call. If you had written the June30Call, your account would be down only $0.50 instead. Now, with the NYX rebounding nicely off its 30 days moving average support guide, you are now in a much better position to hold for long term gains.
HBAN gained 9.4% this past week and its January 2010 call options gained 16% to $1.40. See how leverage is working here? As long as HBAN continues to go up, its Jan 2010 call options would too.
Disclaimer : Neither I nor Masters 'O' Equity or Optiontradingpedia.com and any of the staff, own any shares in DRYS nor hold the above mentioned options trading position. The above article uses closing prices on 5 June 2009. Actual prices on Monday opening may differ. This article is for education purpose only and should not be taken as individual investment recommendation. Options trading is not suitable for everyone and advise should be sought from your local financial adviser.