On April 26th I detailed a hedge idea for holders of Apple (AAPL) stock prior to their Q2 report when the stock was $204:
So what’s the trade? If I were long AAPL, concerned that the stock has run too far too fast, worried that no matter how good the qtr and guidance is will not be enough, or a miss and guide down could be met with a 10% plus drop, BUT you don’t want to sell your stock… you might consider a collar strategy against your long stock…selling an out of the money call and using the proceeds to buy and out of the money put in the same expiration, allowing for upside to a point, but most importantly defining risk in the stock to the put strike. An investor would collar their stock if they did not want to sell it but are more concerned with extreme downside into an event or over a stated period of time then they are about capping gains in the case of extreme upside. It also makes sense to place a hedge in the hours prior to the event to make sure the distance of the strikes lines up with your risk targets.
How a collar would work:
VS 100 SHARES OF AAPL LONG AT $204 BUY MAY 192.50 – 212.50 COLLAR FOR EVEN MONEY
-Sell to open 1 May 212.50 call at $2.15
-Buy to open 1 May 192.50 put at $2.15
And detailed on CNBC’s Options Action program that evening:
The stock was $204, now a few days after earnings the stock is $211. Let’s consider what to do with the hedge.
The Short May 212.50 call that was sold at $2.15 last Friday when the stock was $204 can now be covered for $2.15.
The Long May 192.50 put that was bought for $2.15 last Friday when the stock was $204 can now be sold at 15 cents for a $2 loss.
SO the net of the overlay was a $7 gain in the stock and a $2 loss in the options. I think it is important to remember the reason for putting such a position against long stock in front of a potentially volatile event like earnings… you were willing to give up some potential upside for defined risk to the downside.
And my suggestion at the time was…
It really depends on what you want to do with your stock. If you want to stay long then you have to either make a decision when to cover the short call… do you do it now and lock in the loss on the hedge but allow for more upside, or do you wait until closer to May 17th expiration (two weeks) and see if the stock is below the short 212.50 strike and cover for far less than the $2,15 in premium today, or let expire worthless. At this point It likely makes sense to give it a few more days as the stock seems to have lost a little steam from its initial post-earnings gap of 5% that was in line with the implied move. But at this point, it is very clearly a sort of market call.
Updated on CNBC’s Options Action on May 3rd:
What is most interesting about this trade idea to me is that used the implied move of about 4.5-5% to help inform the short call and long put strikes. The stock went to the call strike post earnings and failed, and on this past week’s downdraft, the long put strike was almost like a magnet.
Now with the stock below the long put strike and both the call and the put set to expire this Friday, for those who held on it makes sense to consider how to manage this trade into Friday’s close.
With the stock at $186.80, the May 192.50 put is worth about $6.50 and the May 212.50 call is worth pennies. So at this point, this hedge that cost nothing has off-set $7.50 of losses from the stock price of $204 on April 26th. At this point if you are long the stock and long the collar it might make sense to pay 2 cents to buy back the short call despite the fact that there is less than a 1% chance the stock is above that level, but the real decision to make has to do with the long put. If you thought the stock could bounce from here, then it would make sense to “monetize the hedge” and close the collar for a gain and let the stock do what it will do. Or with the stock at $187 you could sell a lower strike put to lock in some of the gains of the hedge and allow for more downside protection, too a point. For instance, you could sell the May 175 put at about $1 … at this point with the stock down 5% and no end in sight for the trade issues it makes sense to continue to sit tight and stay long that put to cover in the event of a mini-crash…