How To Take a Juicy Bite Out of a Bruised AAPL

By Ron Litchman - October 2, 2012 | Tickers: AAPL | 0 Comments

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“Trees don’t grow to the sky,” goes the often-heard admonition.  Its wisdom is regrettably discounted when, as often, it is heard (a) too late or (b) when the frustrated admonisher is missing a rally.

We were reminded of late that its truth evidently applies to apple trees.  Orchardmen in Fool-dom will know that apple trees are no sequoias.

My focus here, though, is financial, not arboreal.   I speak not of apple the tree, but of Apple (NASDAQ: AAPL) the Stock, that luscious fruit, the erstwhile AAPL of our eyes – worth (or priced at) over $705 per share less than two weeks ago.

There had been some rumblings, misgivings that the new iPhone5 was not shaking the Earth, that slightly lopsided orb which had only recently paused quaking from the successions of i4, i3, i2 and the original iP.   Which darkly foreshadowed that i5 sales would not add whole integers to GDP.

And, of course, Steve Jobs had passed on, which brought to mind Huck Finn’s investment advice,“I don’t take no stock in dead people.” 

(The Widow "learning" Huck
on "Moses and the Bulrushers")

Even some prominent longtime boosters were expressing “caution.”  No shame in not buying more, they said. Perhaps, not even in taking a profit.  

I couldn’t do that, as I didn’t own any.  But, instead . . .

THE TRADES

On September 19th, a Wednesday, with AAPL hovering over the 700-century mark, I bought a pair of in-the-money October $705 puts, for $21.41, and sold an offsetting pair of out-of-the-money October $675 puts, for $9.41.  That resulted in a net outlay of $12 for the 30-point “debit put spread.” (Any number of pairs would have worked the same way, to scale up, but as we’ll see, there was an advantage of having more than one pair.)

The following Monday, September 24th, AAPL had fallen as low as $683, intraday.

The in-the-money long leg of the spread, the 705-strike, was bid $29.10 – a gain of $7.69 (>36% from $21.41), but the out-of-the-money short leg, the 675-strike, was also up, to $13.80, a loss of $4.39 (>3.85%, having sold them at $9.41).  

Still, because the long leg gained more than the short leg, the spread widened.  The position which cost $12 to enter, could be unwound (by selling the 705's and buying back the 675's) for $15.30 . . . a 12.75% gain over the $12 basis.   Not too bad . . .

(And it was open for only days . . . Anyone care to “annualize” 12.75% in six days . . . well, the calculator says 775% per annum!!  – That was fun.  But that’s not real money.)

Here IS a real point about real money:  The quick expansion of the spread presented an unusual opportunity.  One could sell only ONE of the long legs, for $29.10, and buy back BOTH of the short legs for $13.80 each – and still pocket about $150.  And, also – more important – still hold one long 705-strike put.

A few more days passed . . . September 27th . . .  Apple continued to roll downhill.  Much televised consternation ensued . . . AAPL opened below $669 and proceeded south as far as $661.20 . . . The commentariat crescendoed:   AAPL risked breaking through its  its 21 day moving average . . (why not the 20 day moving average? or the 23 day?  I don’t know.  Need to ask a “technician.”) The whole Apple eco-system was in jeopardy of dissolution.  (Did you hear that Apple is not only a corporation, it’s an eco-system?)  The dialog was just as hysterical at the bottom as it was at the top.

With AAPL about $661, the remaining 705 put briefly hit $48, and for that, I parted with it.  (And even that didn’t even catch the top.  AAPL bounced above 680 since them, but sank below $657 today, October 1st, launching the put contract over $51.)

The position which originally cost $2,400 per pair, sold out for about $4,950.   There was therein a measure of  poetic (as well as economic) justice; as the original investment was subject to the risk of a 100% loss, it was only fair that it doubled.

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My purpose in this writing is not (only) to publish my personal prowess (though rumor has it, in other circles, that’s what blogs are for), but to demonstrate for fellow Fools what tools they may employ to protect their positions, and how those tools work when then do work.  (Which, admittedly, is not always.)

I respectfully submit that it should be deemed no heresy, even for Foolish investors, to defend their hard-won, long-term profits, no less their capital, from short-term diminution.

Even Fools willing to suffer a greater than 6% drawdown, might prefer to avoid that pain, especially where they need not sell out their stock position to do so.  Thus, a portfolio containing a couple hundred AAPL’s when each was trading at 705, amassing what some will consider a substantial nest egg of $141,000, would not have been quite so bruised when the shares shed some 44 points each (that’s down $8,800) where a protective put absorbed nearly a third of that loss.  

And the shares remain in the portfolio to enjoy the rebound, as the AAPL tree resumes its climb to the sky.  (But not today.)

As our hosts are wont to say . . . Fool On!

Ron Litchman
TheTelescopicInvestor@earthlink.net

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