This article is for people who feel they are “speculators” in terms of their risk tolerance for investments.
Today the market is closed for the observance of the death of George H. W. Bush – our 41st President. After seeing the Dow Jones Industrial Average drop by 799+ points yesterday … I’m kinda glad it is closed. Maybe it will have a little time to “heal” … LOL!
On November 29th I published and article about Dollar Cost Averaging, Buying on the Dips, and Swing Trading. I want to continue that discussion here with actual investments I made in Apple Computer Corp. (AAPL) in November. Before beginning, I warn you, this could get “cumbersome” for some … but please try to follow along. First let me present you with a chart of Apple Stock dating from November 1 thru December 4 of this year. Keep in mind as you look at this chart … we are looking in the “rear view mirror” as it is impossible to know what lies ahead. Buying stock is somewhat like driving a car that has no windshield … only a rearview mirror. Thus when I made my first purchase on November 2 of this investment (thought I was buying on the DIP) I had no idea what would follow on November 3rd through yesterday. Unlike many traders, I don’t have a “crystal ball.” I only have past experience to pull from.
Here’s the chart:
As you can see the stock dropped below $220 per share to around $208 per share on 11/02/2018. What did I do? I purchased 1 Call Option Contract with a Strike Price of $210 per share and an expiration date of 01/17/2020 to give it plenty of time to react. The idea and the belief is that by late next year (November or December) the Apple Stock should be trading at higher than $210 per share and I could sell my option back in the market and make a little money.
I had no idea the stock would drop, go up in value a couple of days and start dropping again. Here’s my thought process:
- I could purchase 100 shares of AAPL at an average price of $208.52 on 11/02/2018 and spend about $20,852 (not including commissions) since I already owned a few hundred shares that cost less. Or …
- I could invest in 1 contract of AAPL with a Strike price of $210 for 01/17/2020 and invest only $25.85 per share for a total investment to control 100 shares of stock for $2,585.00 (not accounting for commissions).
What I did know is if the price of AAPL slipped by 10% and I had purchased the stock I would have lost $2,085 in value (which is close to my options premium amount) but that if it went up by 10% in value I would make about $2,085. I also knew that I could lose 100% of my options premium ($2,585) and that was okay since it only represented about 2% of my entire options portfolio at the time. I also knew that if the stock went up by 10% to a price of $229.37 the “intrinsic value” of my option would be ($229.37 – $210 = $19.37) of my total option premium. Naturally, if this happened before my option had much time to lose value because of losing “time value” I could realistically have an option valued at about $35 or more … which could result in a gain of about 40% or more in short order (you will see something similar to this in the last chart in this article … so hang on).
But it did not work out that way.
I woke up on Tuesday, November 13th and realized that my options premium had fallen to a value of about $18.75. I was now down in value from $2,585 to about $1,875 – a non-realized (key word “non-realized”) loss of about 27.4662%. Knowing from my brilliant math scores in school (Crap … I flunked algebra 3X in high school – thank God for Excel and Financial Calculators) in order to simply get back to even my option would have to increase in value by 37.8667%. Not easy to do when you have decaying time value and no intrinsic value. For those who may not know … if the option only increases by the amount it lost percentage wise 27.47% … the premium would only be worth $23.90 which is still below the original $25.85 paid. It’s good to remember that if you lost 25% you need 33.33% to break-even and if you lose 50% you need 100% to break-even. Down 90%? You will need 900% to break-even.
Then I thought … “Hey this may be a good time to BUY THE DIPS.”
Check out this graph of the actual option premium on the 01/17/2020 AAPL $210 Call Option. Remember we are looking backwards and have no idea what is going to happen in the future:
On the 13th there was not much of a Candle at all. This means that the option actually opened the day and closed the day at the same price. In the world of Candle Sticks this is called a Doji and I am not a candle expert so don’t ask me why. However you can see by the vertical “wicks” that the price did trade as high as $19.64 and as low as 17.41 on that day.
I chose to “double down” and purchase two more of the same options contracts at $18.7502 per share. Now if you are keeping score this gives me 3 contracts (same as 300 shares) for which I invested $3,750.03 on 11/13/2018 and $2,585.00 on 11/02/2018. So my total cost was $6,335.03 which equates to an average cost per share of $21.168. What is so great about this? My average cost is lower by $4.68 per share. Now instead of the option having to increase by 37.8667% to break-even it only has to increase by 18.10% or so. Not bad.
Now had I been the stock investor and purchased 200 shares of the stock at the average stock price on the 13th of November when the stock had fallen all the way down to as low as an average price of $191.98 … I would have invested another $38,396 into the 200 shares for total cost now of Apple at $59,248 vs. the total cost in the options of $6,335.04.
Low and behold, the next thing I know it is November 26, 2018 …
the Thanksgiving Holiday is over and I once again take a look at my options. Wow … the AAPL option has now fallen to a price of $9.30 per share. I am officially down over 50% from my second purchase and 64% from my first purchase. If I sell out I will get proceeds of $2,790 back from my investment of $6,335 to date. That is a loss of $3,545.
Then I remember, had I bought the stock instead I’d be down by $6,919 … “so my loss is really not that bad, I thought!” How did I get to a loss of $6,919 on the stock?
I would have purchased the first 100 shares at $20,852 and the next 200 shares at $30,396 for a total investment of $59,248. Then on 11/26/2018 I could have sold 300 shares for total proceeds of $52,329 resulting in a loss of $6,919 – or – almost double what the loss was in the options contracts … again, if I’d sold.
I did not sell. What I did instead was to purchase another 3 contracts (300 shares) of the same option at a price of $9.3001 per share. This required another investment of $2,790.03 bringing my total investment in this option contract series to $9,125.07. Now my average cost per share in this series is all the way down to $15.2085.
Had I purchased another 300 shares in the stock … I’d had to invest another $52,329 bringing my total investment to $111,577 with an average cost per share of $185.86.
Now I have no idea which way Apple stock will go between now and a year from now. I’d guess, however, that if Generation X, Y and Z continue to purchase their products and if the president of the United States and the President of China can get their act together over this “trade war thing,” the price will likely begin to trend up. If it does it will be a whole lot easier for me to hit a break-even price of $15.21 per share than it will to hit a break-even price of $25.85 (which is how high it would have to go for me to break even on the first 100 share contract I purchased. If the option price ever does get back to $25.85 then my 6 contracts would be worth $15,510 which is much better than the $9,125 that I invested in them.
If you look at the chart below you will notice that when the stock was trading for around $230 per share back in September the option contracts were trading for about $42. The blue mountain is the Apple Stock and the prices are on the left … the red and green bars are the $210 options contract and the prices are on the right.
Should that happen again … it could probably sell my options contracts for a value of about $25,200 or so; we will just have to wait and see what happens – and trust me I will keep you posted.
Now for you numbers folk that need to see the numbers … here ya go:
Thank you for your time and please review the disclaimer below.
On 10/21/2019 I closed out this all 6 contracts of this position with a total gain of 120.46% in a period of about 11 ½ months. You can see these actual results below:
The actual closing price on those contracts were $33.53 per share vs. a cost basis of $15.21 per share.
Here’s the bad part … if I’d held for just a little longer … today (I am writing this on 11/08/2019) those contracts are selling for $51.50 per share … so 6 contracts (600 shares) would have provided total proceeds of $30,900 for a gain of $21,775 rather than a gain of $10,992.
However, it does no good to cry over past mistakes … all we can do is learn from them.
This information is not recommendations for you to purchase or sell any investments outlined in this article. The information is being shared for educational purposes only. I recommend that you seek the advice of a licensed and competent financial advisor before taking actions on your portfolio if you see a need to after reading this article. I cannot emphasize anymore than this the importance of following your financial advisors advice when it comes to investments.
The author of this article is long on the following investments outlined herein: Apple Corporation stock and options.