Saturday, March 05, 2016

AAPL 2016 Update #76

AAPL and the markets in general rallied throughout the week. The SPX500 closed near or at 2000 and the DOW is back to around 17000. AAPL also showed strength closing at 103.01 on Friday. If you were short calls on Friday, you should be assigned as the calls closed 0.01 in the money!

The current position on AAPL which is now a covered call (long stock + short call) is profitable (good news!) but at the current price, there are some decisions to make.

Firstly, the position is profitable. That's the good news! At the current price and volatility, the AAPL entire trade is profitable by just over +4100 from the OptionsAnalysis entries. If you recall from the start of this experiment, the position started out by being long 600 shares at 130.16 or 78 255. (Go back to AAPL entry #1)

So, let's look at the differences in P/L between the two:

Unhedged Value - Buy and Hold
(600 shares X 103.01/share) + ($936 dividends) = $62 742


Hedged Value - Actively Managed
78 255 cost +  4 100 profit = 82 355

This is a difference of about 20K for the better. So this experiment has been profitable.

The problem is that the trade is has made nearly as much money as possible unless an adjustment is made. Unfortunately, because the stock has run up and is now very far from the short call, nearly $9 - adjusting the trade cannot be done for free in the near term.

The short 94 call is trading for 9.38 at the mid-point and still has 28d to expiration. To roll this call up to the 95 strike or higher, requires selling a substantial amount of time.

Let's look at two option chains as an example:

Option chain with 28DTE (days to expiration):
Fig 1 - 28 DTE Chain

Option chain with 35DTE 
Fig 2 - 35 DTE Chain

The position is short 8 calls with 28DTE. In order to capture another strike or more in profit, the calls need to be rolled up. But there are two things to consider:

1) the stock is trading much higher than 95. It's currently at 103

2) rolling the short calls up (buying back the 28DTE calls and selling the 35DTE) cannot be done for even money. To move to the next highest strike, which is 94.50 will cost a debit of 0.28.

To understand what this means, the trade will cost 0.28 in order to just gain another 0.50. That is paying $28 to make another $50. Is that a good trade off to roll? It all depends on a your view of risk and reward.

My rule is to try and not pay more than $25 for $100 gain in value, risk 1 to make 3.

Looking at another roll to the 95 strike would cost (9.38 - 8.68) 0.70 in order to capture the next 1.00 move.

And looking further up the chain to the 95.5 strike would cost (9.38 - 8.20) 1.18 to capture the next 1.50 move.

The additional cost of rolling vs the profit gained is the trade off to consider. 

What you definitely want to avoid is paying more for the roll vs the profit potential. In other words, you don't want to pay 1.20 to only gain 1.00 in strike.


Fig 3 - 42 DTE Chain
If the roll values do not work with the current chain, then go further out in time. Fig 3 is the option chain 2 weeks further out in time.

Rolling up to the 95 strike will cost (9.38 - 8.88) 0.50 to capture the next 1.00 move which better than the 0.70 paid from the 35 DTE chain. This is still double what I would like to pay. You get more money for the longer dated option due to extra time value.

Taking this to an extreme we could look at a very far away option chain.

Fig 4 - 231 DTE (Oct 2016)
Looking at the Oct 2016 option chain (231 DTE). We could roll up to the 100 strike for a nice credit (9.38 - 10.05) of -0.67 or all the way up to the 105 strike for a debit (9.38 - 7.5) of 1.88.

In rolling up to the 105 strike, the position would gain 11 strike points (105 - 94) and would cost 1.88 per contract. Percent wise this is 17% of the strike width (1.88/11) and well within my rule of 25% per 1.00 strike.

The question is would you want to do this? There are 231 days before this trade matures and captures the maximum profit and a lot could happen to the stock between then. It could lower or much higher than 105.

These are the types of questions you need to ask when you are rolling any option. How much are you willing to pay for the next strike and how far out in time are you willing to go.

The problem at this point is that because the short calls are so far in the money that rolling them up any significant amount means trading off time for premium.

To "catch up" to the stock price requires paying a premium to move the hedge. That money either to be added to the position, selling time, or come from a sale of the portion of stock.

What to do?

At this point, in the 28 days, assuming the stock trend stays intact the deep in the money short calls will sell the stock position at 94/share and the position turns a profit of at least +4100 (plus any remaining time value in the short calls)

After 28 days, I will have a cash balance of 82 355 in the account and can just go out any buy back the stock again and restart a new collar or covered call position. I will have to buy fewer shares because the stock will higher than the 94 strike at which they get sold. I then just start the process all over again.

Now what if I don't want to wait 28 days? The stock is moving and in 28 days, who knows where it will be?

Let's look at the next expiration cycle in just 7 days.

Fig 4 - 7 DTE
Rather than wait 28 days for the position to unwind itself, I could roll the short 94 calls back in time to 94 calls expiring in 7 days. This will cost a slight debit (9.38 - 9.03) of 0.35/c, but has the advantage of the position unwinding within the week.

By giving up $280 in profit (0.35 X 8 contracts), the stock position can be reset much quicker and a new collar or covered call position started.

There will still be less shares in the new position as I will have to buy shares at the now higher price, but I don't need to wait 28 days for this to happen. I am trading a little profit to avoid waiting 21 more days.

Any of these trades and scenerios are all valid for a trader. The only one that does NOT make any financial sense is to pay more for the roll than the amount gained. ie: don't pay more than 1.00 for rolling strikes in order to just gain a 1pt strike.

What is comes down to how much time you are willing to wait and what you believe the stock will do. At some point the AAPL price will stop and reverse. It will not continue up forever.

What you need to focus on at this stage is that, yes, some profit is getting away -- that is a fact. To capture more profit requires the trade being reset and that will cost money which is going to ultimately come from the sale of some of the stock.

However, without any hedging and even at a price of 103.01 the regular investor is waiting for price to recover a huge $16K deficit before there is ANY hope of turning a profit!



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