Weekend Review – 5/5/2013

Barron’s –

Apple (AAPL – 449.98) got a lot of love in Barron’s this weekend being named number one in a list of America’s top five hundred companies.   Also, the Striking Price column was devoted to AAPL and their decision to raise their buyback to $60 billion and also raise their dividend.  Shorting AAPL puts was the option strategy discussed around these announcements was the strategy that was suggested.  Two examples were given, with AAPL at about 450, either sell the AAPL Oct 425 Put at 21.10 or sell the AAPL Jul 425 Put at 10.00.  The basis for this is that AAPL will probably come in as a buyer of their stock periodically a put some sort of a floor in the share price.  Another idea popped into my mind that goes along these same lines.

Like the majority of liquid stocks there are Weeklys that are listed on AAPL.  As AAPL’s buy back progresses, if some sort of floor in shares develops then opportunistically selling Weekly puts on AAPL may become a profitable strategy.  This is a viable alternative to putting on a position that will take months to work out traders can take a short term position by selling Weekly puts on AAPL.  For example on Friday the AAPL May 10th 440 Put could be sold for 3.25.

The AAPL buyback could also have an impact on AAPL option trading.  It is quite possible that AAPL will sell puts as part of their buyback program.  This could put a little pressure on the implied volatility of AAPL options.  I’ll be keeping an eye on the CBOE Equity VIX on AAPL Index (VXAPL) to see if this increase in the buyback program truly does have an impact on VXAPL.

Options Action –

It was noted that the leaders in this rally have been ‘old-tech’ stocks such as Microsoft (MSFT -33.49) and Intel (INTC – 23.96).  Healthcare is actually lagging which means that the market may be rotating into cyclical stocks.  This would be an indication that the stock market actually sees the economy recovering.  Technically the technology sector is starting to play catch up with the overall market.

The first trade recommendation was on IBM (IBM – 204.40) and in the form of a put butterfly.  Looking out to June, an IBM Jun 185 Put was purchased for 0.50, two IBM Jun 195 Puts were sold for 1.55 each (3.10 total) and an IBM Jun 205 Put was purchased for 4.85.  The net cost of this trade was 2.25 which is the maximum risk for this trade if IBM is above 205 or below 185 at June expiration.  The best case scenario is for IBM to close at 195 where a profit of 7.75 would be realized.  Finally, as far as key price points go, a profit could be realized between 187.25 and 202.75 at expiration.  With so many moving parts a picture will help clear things up.  Conveniently a payoff diagram appears below.

IBM PO

 

The second trade was on Freeport-McMoRan Copper & Gold (FCX – 31.13) and relates to the recent rally in the price of copper.  Despite high copper prices FCX is trading in the middle of its historical valuation range.  The strategy is less exotic that the first trade and involves selling a put.  Looking to July expiration a FCX July 30 Put could be sold at 1.40.  If FCX is over 30.00 at July expiration the profit will be the premium received for the option or 1.40.  If FCX is below 30.00 at expiration and the short position is held the result would be assignment and a long position in FCX with a net effective cost of 28.60.

FCX PO

 

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Russell Rhoads, CFA

CBOE Options Institute

Russell Rhoads, CFA, is a Senior Instructor with the Options Institute at the Chicago Board Options Exchange. He joined the Institute in 2008 after a career as an investment analyst and trader with a variety of firms including Highland Capital Management, Caldwell & Orkin Investment Counsel, TradeLink Securities and…

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