Before Apple (AAPL) reported its FQ2 earnings, we previewed the event and offered some trade ideas. After the stock moved higher, I updated the bullish/stock alternative with trade management breakdowns and what to look for. I wanted to go over that trade as it’s a good example of patience being rewarded. First, here was the original trade idea from May 2nd when the stock was 147.50:
Stock Alternative in lieu of 100 shares of AAPL (147.50)
Buy the May 145/155/165 Call Fly for 3.00
- Buy 1 May 145 call for 4.30
- Sell 2 May 155 calls at .70 (1.40 total)
- Buy 1 May 165 call for .10
On May ninth, when AAPL was higher at 154.25, the original trade was a double, worth about 6.00. Here was our update at that point, from 5/9:
Now, there is $6 at risk, instead of the original $3. The additional reward now possible is down to $4, from the original $7. So on a very basic level, the risk/reward has gotten worse, as we’re now risking more than we can make. But there are additional factors to consider…
First, we no longer have the market moving catalyst we did on entry (earnings). In fact, between now and May 19th expiration, the options market is only implying a move of about $3 in either direction. And that’s good in this case, because we don’t want the stock to move. The longer it stays around the 155 strike, the more profits we have. With the mark to market value of our trade now $6, that puts our new breakeven (of making or losing money from our current mark to market) at $151 (and $159 on the upside).
The stock did sell off as low as 151 but quickly bounced. And now with the stock 158.50 and lower than it was for that update, the trade is worth 8.50, 2.50 more than it was on the update. Even though the stock is lower.
The additional profits are because the trade has gone to parity, and in doing so, the short premium sold on the 155 call line has come in as profits on the trade. Understand how that works and you understand alot about options and intrinsic vs extrinsic value.
Of course with the trade about to expire, it will become long stock, as it’s essentially just a long in the money call on the 145 line with the 155 and 165 lines set to expire worthless. Therefore it can be closed at a profit, even moreso than when the stock was higher 10 days ago.