Using Puts to Buy Apple

by Jay Pestrichelli on October 15th, 2012


At Buy and Hedge, we follow Apple very closely, not only because we are fans of their products or that it is such a popular stock, but because it hold so much weight in the indexes and is the largest company on the US stock exchanges.  For example, AAPL makes up about 5% of the S&P 500 and 20% of the NASDAQ 100.
 
As such we get a lot of inquiries about how to trade so with its pull back, we thought showing two ways to play it would be helpful. As far as trades go, we like to look at time horizons that will capture Christmas sales, so that means February expiration.
 
We almost always talk about using verticals as a means of creating exposure to the stock when it comes to Apple. That means buying one options and selling another of the same type in the same month. The advantage of this tactic usually keeps hedging costs low and is a more effective use of cash than spending $63k to buy 100 shares.
 
However, we’re going to show a different way than using a spread. Instead of a spread, consider selling puts to either generate income or purchase the stock at a lower price. This strategy is referred to from time to time as a replacement for limit orders while bringing in some income along the way.
 
Lets pick a trade as an example. You can sell the Feb 550 put and generate $20 a share.  This trade obligates the seller to purchase the stock at $550 a share and in return gets $20 of income. If assigned, this makes the break even of the trade $530.
 
If Apple stays above $550 between now and February expiration, you keep the $20 and never have to buy the stock. Right now there is a probability of 31% that Apple stays above 550 between now and February expiration.
 
If Apple closes below $550 at February expiration, you are obligated to buy the stock at $550. So that is something you need to be comfortable with, and for us, that is seems to be an attractive position.
 
You will want to make sure you understand the requirement to put on this trade, but the most you will need to do this will be what it costs to buy the stock ($550) minus the premium ($20) per share. That means you will need $530 if you need to use what is referred to as a cash secured put and can be done in any kind of account that has options approval. However, margin accounts may require up to 75% less.
 
Consider selling puts like this when you’re bullish on the stock and don’t mind owning it at a lower price than what it is trading at today.


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