In a previous column I mentioned how I have been writing put spreads on Apple stock over and over for several months, on the theory that it would not go down 10 percent in any 30 day period.
As those of you who watch the market know, the stock went from about $625 to $530 soon after my article was published. Isn’t the stock market great? It certainly teaches us humility.
So there I was “short” the 550 puts as the stock dropped to 530, but with a 540 hedge, so I stood to lose about $6,000 if I did nothing and the stock did not rebound. The $6,000 is computed by taking the 10 points between my short 550 and my long 540, times 1,000 shares (10 multiplied by 1,000 being $10,000) and subtracting the $4,000 in premiums I had received.
So I did what is known as a “roll down.” I bought back the 550 short position and sold the 540 long position in a simultaneous trade (I almost always do option spreads this way so both sides are closed out at the same time) and took my $6,000 loss. At the same time I sold 10 of the 530 puts and bought the 515s to hedge. From this trade I received $8,000 in premiums (premiums tend to go way up when stocks are volatile). So I put another $2,000 in my pocket. But I increased my future potential loss by $15,000 instead of $10,000 (530 less 515).
But this is one of the wonderful things about options. If the market goes against you, there are a number of alternatives you can follow to recoup some or all of your losses. Or lose more, as the case may be. Soon after I did this trade Apple stock went back up to about 533, and indications are good that it will not drop below 530 and take away my hard-earned profits. Time will tell. As of Monday, the stock dropped by nearly 8 points to 660.
At the same time that I was looking at a possible loss on Apple stock, Bank of America (BAC) also went down. As some of you, whose eyes do not glaze over when I’m talking about options, will recall I have been selling puts on BAC against a January 2013 “leap,” a long-term hedge to protect against a decline below $5 for the balance of this year.
The last put I wrote was at the top of the market for BAC, when the stock was $9 or so, and I sold the 9 puts with a 30-day life. Quite soon thereafter the stock began to drop, and is now at about $7. If it stays there until expiration in June I will lose $2,000, and give back all of the profits made on this strategy so far and then some. But I’ll keep following the strategy until the end of the year, and I remain optimistic that overall I will show a profit. I believe that statistically writing 30-day puts against a one year leap will , in the long run, be profitable. Or not.
Finally, I consider this nice dip in the market as a buying opportunity. I’ve been buying small additional positions or taking bullish option positions in Whirlpool, Xerox, Staples, Proctor & Gamble and even Green Mountain Coffee when it dropped to $24. I sold the $20 puts on Green Mountain figuring that since it’s dropped from about $100 a share to $24 it might have hit its low. It does have a significant customer base of installed coffee machines that require one cup capsules, and coffee has made the headlines lately as being good for the health.
If coffee sales do increase, and Green Mountain sales move up, it certainly will improve my outlook and therefore my heath.
For information about Merv Hecht and more details on the strategies and stocks he writes about in this column, visit his website at DoubleYourYield.com.