A generic image of multiple stacks of coins

Options Trade of the Day: Betting Bullishly on Apple Inc. Without Losing Your Shirt

A generic image of multiple stacks of coins
Shutterstock photo

Apple Inc. ( AAPL ) has been impressive this year, with the shares rallying more than 37% since the start of 2010. The stock is even threatening to push past the psychologically important $300 level. Given the stock's strong price action, most investors -- myself included -- would be loath to bet directly against shares of the Cupertino, Calif.-based gadget guru. But what if you could profit from the stock's persistent elevation, while hedging against any pending weakness in the security? With options, you can.

Take the following short vertical put position, for example. At about 9:51 a.m. Eastern time, a block of 4,000 AAPL January 2011 240 puts traded at the bid price of $5.90, or $590 per contract, on the International Securities Exchange (ISE). At the same time, a block of 4,000 AAPL January 2011 230 puts crossed on the ISE for the ask price of $4.40, or $440 per contract. The result is a short vertical put spread, more commonly known as a credit spread , on Apple Inc. This options strategy is also known as a short put spread, or a bull put spread.

AAPL put option volume details

The Anatomy of an Apple Inc. Short Vertical Put Spread

Getting down to business, the trade breaks down like this: The trader pays $1.76 million for 4,000 January 2011 230 puts -- ($4.40 * 100) * 4,000 = $1.76 million. Meanwhile, the trader receives a credit of $2.36 million for selling 4,000 January 2011 240 puts -- ($5.90 * 100) * 4,000 = $2.36 million. As a result, the trader has pocketed a net credit of $600,000 -- $2.36 million - $1.76 million = $600,000. The breakdown for this credit spread is listed below:

AAPL short vertical put spread breakdown

Breakeven for this trade is equal to the sold strike minus the credit received, or $238.50 --- $240 - $1.50 = $238.50. The maximum gain is equal to the total premium received -- $600,000 -- while the maximum loss is limited to the difference between the January 2011 240 put and January 2011 230 put, minus the net credit received, and is reached if AAPL trades at or below the purchased January 2011 230 strike. In this case, the maximum loss is $9.50, or $950 per contract -- (240 - 230) - $1.50 = $9.50. Below is a chart for a visual representation:

AAPL short vertical put spread profit/loss chart

Getting Technical

So, you may be wondering why the trader would choose the 240 and 230 strikes. While I certainly can't get inside the head of this trader, I can relate potential benefits of selecting these levels for this particular AAPL trade. It is important to remember that your goal is for both puts to expire worthless. As such, technical support should be front and center in your option selection.

Taking a look at the 240 level, we find that this region is home to strong technical support for AAPL, as the shares have closed only two weeks below this level since March. What's more, AAPL's 40-week moving average is rising into the area. This trendline marked the stock's "flash crash" low on May 6.

Weekly AAPL chart since January 2010 with 40-week moving average

The combination of long-term technical support and trendline support makes the 240 strike the idea site for the sold strike in this short vertical put spread. As for the purchased 230 put? There is no real mystery, as it is the next lower strike available, thus helping the trader to limit losses to a reasonable level should the worst-case scenario come true.

Click here for the new summer issue of SENTIMENT magazine

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

All Rights Reserved. Unauthorized reproduction of any SIR publication is strictly prohibited.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

In This Story


Other Topics