This is a rebroadcast of OICs webinar panel. In this deep dive discussion, Frank Fahey (representing...
How to “Buy” Apple for Less Than $255 Per Share
08/18/2010 12:01 am EST
Many traders are looking at AAPL as a potential buy right now, but the share price of around $255 can be a little daunting and will make position sizing very difficult. This is a solvable problem, but it does require a little education and a high risk tolerance. For our example, imagine that you feel that AAPL is on the verge of a breakout and you want to buy the stock but can't manage the high share price. You could buy a call option, which will reduce the cost of the trade, but time value will erode the value of that position unless the stock moves right away. Similarly, you could sell a put option, which puts time value in your favor but caps your upside while still leaving your downside "unlimited." Why not trade off the advantages and disadvantages of these two ideas and do both?
Buying a call and selling a put at the same time with the same expiration month is often called a "synthetic" long position. That spread will profit like the stock will if the market rises, but it won't lose more (in absolute dollar terms) than the stock if the market falls. The advantage of this trade is that the capital requirement is limited to the margin your broker will require for the short put. Lets compare the two strategies.
Buying 100 shares of AAPL is a straightforward trade. The stock is currently worth about $255 per share and the position would cost $25,500 to enter. If the stock rose $30 in the next month or two, you would have profited $3,000 total, or about 12%.
Alternatively, you could buy the January 260 calls for $24 per share (at the time of this writing), or $2,400 per contract, and simultaneously sell, or "write," the 260 puts in the same month for $23.50 for a net debit or cost of $.50 per share, or $50 per spread. Your broker will still require you to provide margin or coverage on that short put that can be estimated as close to 20 times the strike price ($260) of the short put, or $5,200. If the stock rises $30, this position will be up $3,000, or 55%. As you can see, the percentage return is much greater than the outright long position in the stock itself because you invested less capital in the trade.
Effectively, you have constructed a position that will profit just like the stock if it rises and has the same risk exposure to the downside (in absolute dollar terms), but you have only used one-fifth of the capital required to buy the stock. The short put offsets the disadvantages of the call's time value while the long call leaves the upside unlimited.
This all sounds great, but there are two important factors to consider. A synthetic long trade is essentially a leveraged position, and leverage equals risk because it can be easy to get into a position that is too large. How much you use leverage is something that will vary depending on your risk tolerance and sophistication. Additionally, unlike the stock, the options will expire in January. You cannot stay in this trade indefinitely, and planning for that expiration is important. If you want to learn more about this kind of strategy, click the video link below to visit LearningMarkets.com.LearningMarkets.com
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