Tuesday, March 29, 2016

AAPL 2016 Update #79 (Stock Re-purchase)

The cash balance available from the stock assignment (sale) as well as previous trade credits is 76,941

The cash balance that is actually available is 78 313

That is a difference of 1372

This "extra" is a residual cash balance that was in the account before the transfer. I will be adding this into the trade.

There are two things that need to be done when the market opens:

1) Purchase Stock
2) Hedge Stock

Stock Purchase

The stock is opening higher today and is trading around 106. If I am to use the majority of the cash balance to re-purchase stock, I can purchase approximately

78 313 / 106 = 736 shares AAPL

Add this to the existing 50 shares in the account, that will be a total of 786 shares needing to be hedged.

Because is not an even number of shares and the account is not allowed to trade on margin, the closest number of calls I can sell will be 7. This leaves 86 shares unhedged. On the upside this will act as slight kicker so that in the case of the stock moves past the short strike, 86 shares will continue to make money.

Likewise on the downside, these 86 shares will be un-hedged.


I need to look at a couple things when starting a new hedge on AAPL. The first is that current implied volatility (IV) is actually very low, as low as bottom range of 6-10% (of 1 a year range) for options expiring in the next 7-30d.

Looking out a little further in time at the 30-60d, the volatility is a little higher (22% of a 1 yr range) due to the fact that earnings in AAPL will be coming out in around 35d. This is called volatility skew.

This data is available in OptionsAnalysis (OA) on the IV chart.

What this means is that time premium for the options are among the cheapest (least inflated) its been in a long time.

Cheap volatility means that buying put options right now are extremely cheap and it is a good time to purchase a hedge.

The second and flip side to this is that call premiums are not very expensive. Selling calls very near term means that you won't be able to go very far out of the money (OTM). To go further out, one needs to go further out in time.

Remember with a collar, I want to sell premium in the calls and then use that to purchase puts (insurance). Because the premiums are cheap, it is very easy to hedge the downside that is just a few points out of the money.  As volatility expands, premiums will inflate and it will become more expensive to hedge. If the stock were to suddenly drop, this is now the time to be purchasing protection.

What to do?

A lesson in Volatility

Ideally, it would nice to get long some volatility because the expectation is that volatility is going to reverse and start rising. Volatility is cyclical. It deflates and then re-inflates.

Getting long volatility (vega) is most easily done with a slightly out of the money or at the money calendar spread. (A calendar spread is selling a near term option backed by a long option further out in time).

In fact, since the end of last week, volatility has started to tick up slightly in this name.

Expanding volatility is beneficial to the long option (long put) and works against the short option (short call) at a given price.

However, time decay within the 30d window balances out implied volatility expansion. Time decay is more and more powerful as the option closes in on its expiration.

The options expiration cycle that is going to expand most greatly is the cycle during the week of earnings. The closer we get to AAPL earnings, the volatility is going to be spiking and across the board all volatilities are going to be rising. This is also the time where price movement can be most dramatic.

Back to the Collar

I can purchase a collar for zero debit (or slight credit) and have full protection to the downside or I can just sell a near term call option and collect premium. If the stock were to suddenly drop, I can roll the short call down and use the proceeds to buy put protection - although it will have to be at a further out strike. If the stock drops without the PUT already in place, there will be a greater loss to the position as the calls get rolled down.

With the collar, the position makes net money if the stock advances -- the options will lose in value.

With the covered call the position makes net money if the stock advances, but I have the added benefit of collecting and keeping the premium (it wasn't spent on the put).

Both choices are fine as long I remember to keep managing the delta of the position. If I choose a covered call, I will be selling an option closer to the stock price. With a collar, I can be a little further out.

Because the volatility is cheap on a relative basis, I want to purchase protection during right now for the week of earnings. Earnings is in 27d and the closest expiration cycle that contains earnings is 31d.

I also want the collar to have a certain level of protection. Between 25-35 delta per option is ideal. That gives sufficient space between the strikes yet provides a large degree of protection against any downside move.

With these criteria in mind, here is the trade to structure:


Part 1 - Purchase Stock

736 shrs X 106.27 = 78 214

Part 2 - Hedge stock position with a collar 31 DTE, capturing the earnings cycle.

-7c 110 Apr16 W5 @ 1.79
+7c 102 Apr 16 W5 @ 1.69
Net credit: 0.10/c

This is a 8 pt wide collar that gives the stock room to move and adjust on both the up and downside. The 4pt move is currently inside the 1SD band for the stocks projected movement (blue), so its very possible that either strike will be touched at some point in the 31d.

Here is the overall risk profile as calculated by OA. Notice that with the collar on, the position does lose money until around $87/share, well outside the 2 std deviation (2SD) band for an expected move in price.

Fig 1 - Collar Risk Graph 100-110

And here are the deltas to watch. The position currently hedged with -63 deltas. Against long stock, this is 62% protected against a downside move.

Fig 2 - Delta hedge from Collar

31d is hopefully enough time to have the stock move a number of strikes hopefully some opportunity to make an adjustment to either the short calls or long puts.

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