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Friday, October 23, 2009

21 Breakout Stocks to Watch & Using Apple LEAP Options to Generate Income

Here is a list of 21 stocks which traded higher Thursday on unusually higher volume. I have added all 21 of these stocks to my watch list (and invite you to as well), but chose only one to write about in detail in this post. This post requires the knowledge of stock options. To learn more about the option strategies outlined in this post, risks, pricing, calculations, other strategies, and options in general, click here.

The table below shows the company, ticker, Thursday's per share % increase, and Thursday's volume increase (% increased compared to 50 day average). For your convenience I have ranked the stocks in order from greatest to least volume % change.

Company Ticker Price Change Volume Change
E C Tel Ltd ECTX 16.35% 12466.46%
Lucas Energy Inc LEI 24.10% 3259.18%
Chipotle Mexican Grill B CMGB 14.35% 1250.59%
Skechers U S A Inc Cl A SKX 14.34% 490.91%
F 5 Networks Inc FFIV 15.58% 469.94%
Alexion Pharmaceuticals ALXN 8.34% 430.12%
Terremark Worldwide Inc TMRK 6.72% 390.02%
New York Times Co Cl A NYT 22.51% 385.99%
J Crew Group Inc JCG 15.24% 339.98%
Oilsands Quest Inc BQI 6.29% 332.36%
P N C Financial Svcs Grp PNC 12.66% 328.76%
Edwards Lifesciences Cp EW 6.95% 307.47%
Goodrich Corporation GR 7.17% 275.39%
East West Bancorp Inc EWBC 19.14% 239.24%
Thomas & Betts Corp TNB 6.93% 237.30%
T N S Inc TNS 4.55% 198.84%
Lubrizol Corp LZ 7.26% 162.52%
Jefferies Group Inc JEF 2.07% 138.89%
Novellus Systems Inc NVLS 6.80% 94.77%
Apple Inc AAPL 0.14% 65.17%
Charming Shoppes Inc CHRS 8.01% 51.57%

I have chosen Apple (AAPL) to write about in this post. This is a bullish and income generating strategy I have been using on Apple.

Apple Option Trade: Apple beat the street expectations Monday and the stock has been in a steady up-tick ever since. The strategy is a Call spread using two different months (Diagonal call spread). Looking ahead to January 2011 I can purchase the Apple LEAP 100 strike call options for just under $109 a share or $10,900 per option contract - paying less than $4 in premium. The delta on this option is 96.1 (very close to 1 - which is as high as it can get), or for every $1 move in the underlying Apple share this contract moves the same direction by 96.1 cents a share $96 per option contract). I choose this over the stock, because it is like owning 100 shares of the stock for half the price, or using some leverage. Once I own this contract I can then choose to write a call option contract against it (preferable near term and out of the money). I am looking to write out the December 230 strike options against this particular contract. I would receive $240 for this contract. If Apple continues to rally and expires in December at or above $230 a share this position would return 11.2% in less than 2 months. If Apple does not reach this price and expires below 230 at December options expiration It can be written for a similar strike for any of the following months. Writing the options out monthly will lower the contract cost of the LEAP 100 Apple contract which was purchased. The December contract would lower the cost of the LEAP by roughly 2.2%. I will continue this strategy until I either get called out or the contract exercises (assuming Apple shares will be at or above 100 at January 2011 expiration). It is essential to know when to close or roll this position when using this strategy.

I have used this exact strategy with American Express (AXP), Bank of America (BAC), Caterpillar (CAT), General Electric (GE), Google (GOOG), Goldman Sachs (GS), MasterCard (MA), and Visa (V) in the past, and I have found it has given me much greater gains than holding the stock and writing calls on the underlying. To understand how to create spreads using options and when the best time to close the position is check out my Simplified Stock Option Trading E-Books.

The ideas outlined above involve the use of stock options. The reason option volumes have surged in the last 5 years is because they are a great way to hedge your portfolio as well as create income off of your shares (see option volume chart).

These are just examples and are not recommendations to buy or sell any security; if you're more bullish/bearish, you’ll want to adjust the strike price and expiration accordingly.

Disclosure: AAPL December 200 Call Options, AAPL January 2011 100 Call Options, AXP, BAC, GOOG January 2011 300 Call Options, Visa November 60 Call Options, Short AAPL November 220 Call Options, AXP November 38 Call Options, AXP November 32 Put Options

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8 comments:

Anonymous said...

Marco --- can you please comment on the advantages of diagonal spreads versus vertical spreads for AAPL in this case. When would you chose a vertical spread over a diagonal in this situation? Thanks much!

Marco Hickey said...

I stated it is an income generating strategy which the Diagonal call spread would be a better choice IMO than vertical. You would pay less for the vertical spread initially, but if Apple continues a steady uptrend (which I believe it will) it will give you the chance of creating the income off the lower strike monthly, until it is called out or the LEAP expires. I used a vertical call spread when Goldman Sachs upgraded Google, and it seems to have been a good call, but an early one. The higher strike on Google was written for 560, and it is trading close to that now. If I would have been writing it monthly, I may have been able to close it sooner and created additional income for months of September and October... Let me know if you have any other questions.

Anonymous said...

If you were to be called out on AAPL, could you explain what would happen to the Long Call? It seems to me that you would always roll the Short Call to make sure it is OTM. Please advise.

Thanks

Ken

G2 said...

The Apple spread seems nearly risk free for steady income. If Apple goes down in a market correction the base $100 call will always be worth at least $100, right? You just keep selling the out of money options. What happens as you get close to the underlying $100 expiration? Sell it or just let it expire and get the money back?
thanks!!

Marco Hickey said...

Ken, the long leap call would still be in your account. The broker would not exercise or sell it. Rolling seems to be the best choice, but if one wanted to close it he/she would want to do so as the near short option delta equaled the LEAP 100 option on Apple.

G2, the base call would not be worth anything if Apple dropped below $100 a share by Jan 2011 expiration. It seems like it couldn't happen, but as we know anything goes in the world of investing. The premium for the LEAP option is quite small, but it will always be worth at least the amount of $ Apple is above $100 per share. As the option expires you can choose to close the position and purchase a similar LEAP option on Apple or you can let it exercise and take 100 shares for $10,000 per contract.

Anonymous said...

Thanks Marco for your response. One of the problems with being an non-professional (Amateur) is that we don't always explain ourselves well. Let me try again: You wrote the AAPL Dec 230 Call. Time passes and it is now the morning of the 3rd Friday in December and AAPL is now worth $235.00. One alternative is to Roll the December 230 Call to a higher Strike Price, but it is the other alternative that concerns me. And that is that I do nothing and as a result my 230 Call is assigned and I must deliver AAPL to someone at $230.00 ($23000.00.) Does the broker exercise the 100 Call? In other words, "What happens?"

Ken

G2 said...

It seems that this strategy is only viable if Apple is above $200 as you reach the expiration. You need to unwind the leap at some point between now and expiration. If the bears are right then we are due for a correction. The leap would be in the red for some time. Wouldn't this be a better trade to wait for the correction and then do it?

Marco Hickey said...

The question is what if a correction doesn't come anytime soon? And what if it comes and Apple doesn't sell off too much... Anything could happen.

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