Thursday, March 22, 2012

protect $AAPL for free not $VIX

The cnbc fast money crew often recommend to 'buy protection when it's cheap.' By that they mean by vix calls which will go up as the market sells off. The only problem is that recently the $VIX pricing is strange and unpredictable (cash price now is 15ish yet if you look at April futures it's 18.4; May futures it's 21.5).

Instead of messing with the vix, here is an alternate strategy to protect your Positions. I will use aapl since it's the wall street darling as of late:
* say I own 100 shares of apple; current price is 600. It doesn't really matter where i bought; what matters is that i want to continue to own it but am a little nervous about a sharp decline. I can stomach a little drop but not a woosh down.
1) I can buy April 1xaapl 580 put. This give me the right to sell my stock at 580 even if it drops to 0. this will cost me $12.5x100= 1250. That's a lot of money just for protection. I am going to make it cost me nothing by
2) To finance step number 1, I sell April 1xaapl 620 call. This obliges me to sell my stock at 620 regardless of what market price is in April. for this i will collect $12.5x100=1250.
So between the money i paid to buy the 580 put (protection) and the money i collected for selling the 620 call, this combination cost me NOTHING.

Possible outcomes:
1) aapl goes nowhere (stays between 580 and 620): both the put I bought and the call I sold will expire worthless. Not a waste of time since i slept better knowing that i limited my downside risk holding my apple stock.
2) aapl drops below 580: my loss is limited to 580 ($20) and i can exercise my right to sell it at 580 (even it is dropped to 550, 500 or 100). hidden fast money trade here: If aapl drops to say 575 and i feel like it's a temporary drop rather than an exodus from aapl then i may decide to sell my protection since now it would be worth 1000% more than i paid for it and keep the stock waiting for recovery. The 620 call i sold will expire worthless (didn't need to use it)
3) aapl runs to 650 700 or 1700: i may be forced to sell my stock for 620 like i promised when i sold the call. Big deal since this means that I got my protection for free and participated another $20 up in price appreciation.

Btw, if you like these posts spread the word, folo @racernic & peruse the rest of my post including the sides (if you know what I mean ;-). I do these post for free and have no subscription pitches etc.
TRICKS: in the above example I can get more creative. take the exact scenario BUT if i feel that aapl is toppy and won't break 615 before 30days from now, i can buy the 580 put BUT sell the april 615 call instead of the 620. why? the 580 put cost me 1250; the 615 call gives me 1423 so i actually make money putting on a safety trade.

As with any trade there are risks but in this case the I am very comfortable with the dollars at risk. I always try to know and manage my risk; I ask 'what will I lose if the crap hit the fan in the worst possible way.' If I know the answer to this and am ok with it then I should be ok.

THIS IS NOT A RECOMMENDATION OF ANY KIND. I ONLY INVEST MONEY I CAN AFFORD TO LOSE.