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January 4, 2016

Apple Stock or Call Options

Apple Inc. (AAPL) stock is much cheaper to purchase now then it was before its split back in June 2014. And even though it has declined over the last month, it is still rather pricey for many investors. You might believe that this stock, despite its recent dive, continues to have tremendous upside potential and could easily make it back to $120 relatively soon. The problem is that you don’t want to shell out about $107 for one share of the technology giant. What can you do to maximize your money and cash in on the perceived upside? Easy, buy a call option rather than the stock.

Quick Definition

A call option is a bullish strategy wherein a trader purchases the right (but not the obligation) to purchase a stock at a specified price within a specific time period. One advantage to buying a call option rather than purchasing a stock is that you can gain a much larger percentage return on your investment. To learn more advantages, please check out the Options Education section on our website.

The Example

If you want to purchase 100 shares of AAPL stock at $107, it is going to cost you (100 X $107) $10,700. However, let’s say that you decide to purchase 1 call option on AAPL (each option represents 100 shares) with a strike price of, say 100 with a July expiration (gives the buyer the right to purchase 100 shares for $100 a share). This call option carries a price tag of $12 and has about 200 days until expiration. Rather than dishing out $10,700 for 100 AAPL stock shares, you instead pay $1,200 for the options – a rather nice difference of $9,500 that you can use for something else or to purchase other options.

The Money

The cost efficiency of purchasing call options can be far greater than simply purchasing shares of a stock, especially when you are dealing with high-priced stocks like AAPL. Remember that one option contract is the right to purchase 100 shares of a stock at that price. So, rather than purchasing 100 AAPL shares at $107 at the massive cost of $10,700; you have dished out a more reasonable $1,200 for the transaction. Of course this is a scenario where a trader would be simply bullish on AAPL stock.

Conclusion

As you can see, it is possible to lay out far less money to purchase call options on a stock that to by the call itself. In fact, the earlier the expiration you choose, the lower the price you could pay. No matter what math you use, paying $1,200 is far better than paying $12,000 for the same product. What if you want to sell these options to someone who is willing to pay a higher ask price than you paid? That is another subject for another time. Remember, there is no fool-proof way to make money in the market – there is risk involved in any trading strategy. One way to make sure you maximize your cash is to make sure you study your subject, remember that knowledge is power.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring

June 18, 2014

AAPL Butterfly After the Split

There has been more talk than usual about Apple Inc. (AAPL) before and now just after the split. Several traders have asked me about what type of AAPL option trade they can use if they think AAPL will rise to around $100 in a few short weeks. Truth be told, there is more than one option strategy that can profit. But an option trader should consider a directional butterfly spread particularly if he or she has a particular time frame in mind as well. Depending on how the butterfly spread is structured, the option trader can structure a high risk/reward ratio for the spread. Let’s take a look at this option strategy.

The long butterfly spread involves selling two options at one strike and then purchasing options above and below equidistant from the sold strikes. This is usually implemented with all calls or all puts. The long options are considered to be the wings and the short options are the body of the butterfly. The option strategy objective is for the stock to be trading at the sold strikes at expiration. The option strategy benefits from time decay as the stock moves closer to the short options strike price at expiration. The short options expire worthless or have lost significant value and the lower strike call on a long call butterfly spread or higher strike put for a long put butterfly spread have intrinsic value.

As mentioned above, if an option trader thinks that AAPL will be trading around $100 in about three weeks, he can implement a long call butterfly spread with the sold strikes (body) right at $100. Put options could also be used but since the spread is being structured out-of-the-money (OTM), the bid/ask spreads of the options tend to be tighter versus in-the-money (ITM) options which would be the case with put options. The narrower the option trader makes the wings (long calls) the less the trade will cost but there will be less room to profit due to the breakevens. If the butterfly spread is designed with larger wings, the more it will cost but there will be a wider area between the breakevens.

At the time of this writing, AAPL is trading around $92. An option trader decides to buy a Jul-03 97/100/103 call butterfly for 0.15. The most the trader can lose is $0.15 if AAPL closes at or below $97 and at or above $103 at expiration. The breakevens on the trade are between $97.15 (97 + 0.15) and $102.85 (103 – 0.15). The maximum profit on the trade in the unlikely event AAPL closes exactly at $100 on expiration would be $2.85 (3 – 0.15). This gives this option strategy a 1 to 19 risk/reward ratio. Granted AAPL needs to move higher and be around $100 in three weeks but one could hardly argue about the risk/reward of the option strategy or the generous breakeven points of the spread.

This AAPL option trade may be a bit overwhelming for a new option trader to understand and there is more than one way to take a bite out of AAPL with a bullish bias. A directional call butterfly spread in this instance is just one way. A big advantage that the directional butterfly strategy may have over another option strategy is the high risk/reward ratio. The biggest disadvantage is the trader needs to be right about the time frame in which the stock will trading between the wings since maximum profit is earned as close to expiration as possible.

John Kmiecik

Senior Options Instructor

Market Taker Mentoring