Thursday, February 26, 2015

AAPL Case Study - Opening (2015)

Feb 26

Introduction

Disclaimer: This is for educational purposes. No guarantees of return are made or implied. Past results does not guarantee future performance. 

I am going to track the performance and details of trading a plain collar position around stock. To understand the premise dynamic hedging, you can find more information to learn about it here: Randomwalktrading.com 

The stock I am choosing to hedge is Apple Inc, ticker symbol AAPL. This meets the criteria for dynamic hedging. Its shares trade high volume and has exceptional liquidity. It has the tendancy to move significantly, upwards and downwards which is key for this strategy to be effective. There are tight bid/ask option spreads for ATM and slightly OTM strikes - 0.05 or better for both the weeklies and regular expirations. The tight bid-ask spreads is a sign of liquidity. The option strikes are also in increments of $1 in the weekly series. This allows for easy and more precise adjustments, especially for a high dollar value stock.

Though it split 7:1 a year ago, it still has volatility moving +/- $5 per month or more. It is moving in a longer term bullish trend with lots of random up/down movement to feed the collar. The large swings are beneficial to the collar.

A key for the collar to work is to have a stock that is generally moving upwards, and lots of price movement. The swings need to be wide enough to allow the collar to be traded and stock accumulated.

Stocks that have little movement month to month, trade with low volume and have illquid option markets are not candidates for this strategy.

Trading commissions will be excluded from the calculations to simplify details. On average a 6 lot of options will cost around $17 to trade with TD Waterhouse. A stock purchase is $10.

Opening Position:

Long 600 Shares AAPL
Average Book Value: 69.23

Closing value on Feb 26: 600 shrs x 130.42 = 78,252

This is an important value and I will be referring to it in future posts when comparing the performance of the collar to just holding stock.

Analysis

The stock is in a long term uptrend. No other hedges were traded on this position prior today.

The stock spiked above 130 on the Jan earnings report (traditionally its strongest quarter), is trading above its post-split all time high, and may be ready for a pullback. On the daily chart, a large bearish candle formed on a slight gap down.

Trades

This structure (a conversion) locks the position value for the next two months. 

Sell 130 Apr 15' Call @ -5.26
Buy 130 Apr 15' Put @ 4.40
Net Credit -0.86

I chose the Apr expiration to give the hedge plenty of time to work, approximately 45 DTE.

This is a perfect hedge (-100) delta for stock at 130 strike. The position was initiated for a net credit and will lock in the positional value at $78,000 (600 shares at 130) plus $516 ($86 x 6)

The conversion is done for a slight credit as it was done with the stock trading above the 130 strike and has some time value.

The hedge will carry away the stock at expiration, unless the hedge is adjusted.


Value

Net position value at expiration of the conversion and stock. The position will be worth slightly more than 600 shares due to time value of the options being sold.

78 000 (stock value) + 516 (credit from conversion) = 78 516

-End