For some time now we have stated our belief that AAPL stock would likely remain range-bound through year end. On November 10th we detailed a trade to add yield for those that were long AAPL stock. Here was the trade and rationale at the time:
vs 100 shares of AAPL ($116.20) sell the Dec24th (weekly) 105/125 strangle at 2.15
Break-Even On Dec 24th weekly expiration:Rationale – This adds just under 2% in potential yield on underlying shares over the next 6 weeks, a period that could see lower levels of volatility given the upcoming holidays. The risk on the overlay is being put 100 shares of stock at 105 or lower, and having 100 shares of long stock called away at 125 or higher. So a long holder is giving up potential upside, and having risk to adding long exposure on the downside for the potential to add 1.85% yield if the stock remains range-bound between 105 and 125. If the stock were approaching or through either strike heading into Dec 24th weekly expiration, you could simply take off the short strike to keep the long stock position intact.
The ideal situation for long holders would be for the stock to grind higher have the gains of the stock, and cover the short strangle for a gain close to expiration.
We updated our thoughts on December 2nd when AAPL stock was around $117 and the strangle was worth about .50:
This has worked well. AAPL has basically gone sideways since we wrote this and the strangle is now worth about .50. That can be closed right now for a nice added yield but you can probably be a little greedy with this. As long as AAPL isn’t threatening either strike in the next few weeks those will probably be able to be closed for less that .20 and rolled out to January as well.
Despite a couple weeks having passed since the last update the trade is actually less of a profit now. And that’s despite the stock not really having moved that much closer to either strike than when it was worth .50. Why? Implied vol.
When the stock was 117 it was $8 from the 125 strike, with the stock 111 it’s $6 from the 105 strike. Under normal circumstances the straddle would prbably be about the same as it was 2 weeks ago or even slightly less (for more gains). But with the VIX now above 25, look at what’s happened to AAPL 30 day at the money implied volatility:
Thirty day at the money implied vol in AAPL has gone from 20% to 30% in a matter of weeks, without any stock specific news. The Dec 24th puts are above 40 vol here. So the end result is a short strangle that has gained in value over the last 2 weeks rather than decay. With AAPL at 111 the short strangle is worth about .85.
This make sense because there suddenly seems to be risk of a fast broader market move lower. Although it doesn’t always feel great to close a short option trade after a vol spike, sometimes it makes sense to be disciplined, especially when you have a winner. Therefore we think it makes sense to close the strangle here for a 1.30 gain and book the yield. The stock is down about $5 since the trade was detailed and that softens the blow of stock losses by more than 1%.
With vol now high it offers a great entry to roll this trade out to January, but we like to wait to see where AAPL finds a bottom first. That way the strikes can be set with more confidence and even if the stock bounces first, implied vol will still be a good entry as it usually takes some time to settle back to historical averages.