Stocks Gone Wild - Until Apple Covered Call Crashes The Party

For some time now, I’d been employing covered calls as a means to generate income in a down/flat market. More recently, with markets rallying 60% from their lows, the Apple (AAPL) covered calls have come home to roost. For a detailed background and example of how the Apple position was structured, see How Covered Calls Work. While I’ve captured thousands of dollars in option premiums from my Google Credit Spreads and Apple covered calls over the past 2 years, it’s not a free ride. You do of course forgo unlimited upside when a stock runs unabated like Apple has in recent months.

My most recent covered call position for Apple was opened during the crisis when shares were trading at $96 per share and I sold covered calls along the way as shares slowly moved upward. More recently though, shares zoomed right past 160 to over 200 as of today. As such, I had to start thinking about the exit strategy for the covered call which was well into the money.

I had two options:

1) Leave the position alone and let someone execute the option and lose my Apple shares at 160 per share: Since I owned 100 shares, whatever the share price does from here (unless it dropped back below 160 quickly), my net cash position is unchanged; the shares and the option price move virtually 1:1.

or

2) Buy back the call option (granted, at a much higher price than what I got for it initially) and do whatever I want with the underlying shares.

I opted for #2. Why?

I didn’t want my 100 shares of Apple called away without any control over the situation. Due to the wash rule I wouldn’t be able to buy back shares for over 30 days and I don’t want to miss out on continued upside I foresee for the stock. But since I took a hit on buying back the call (a cash hit only, offset by 1:1 paper gains in 100 AAPL shares), I sold off some of my position to take some gains on the shares as well. My portfolio allocation was way out of whack. My initial entry point for Apple was 96. With shares running up 110% since entry, Apple now comprised over 30% of my trading portfolio. That’s simply too much in a single stock, even though I like its prospects.

Outcome - I ended up closing the call and selling 50 shares of Apple at $203 for a gain of over 100% on those shares. While I paid $4400 to close the call, I took in $5350 in cash from the Apple shares. I’m still holding the remaining 50 shares.

Note that there was just a wee bit of option premium left on the the open Jan 160. I intentionally waited until after this week’s earnings release to allow for the volatility premium to drop out so I wasn’t paying for additional premium unnecessarily. As recently as a few weeks back, the option premium was over $400; today it was closer to $100. So, I paid an extra $100 over intrinsic value for the peace of mind in closing the position out with a great overall gain. Obviously, since I sold the option initially for around $1000 my net gain on paper has still been close to $10,000 considering the capital appreciation plus the prior covered calls minus the $4000 to buy back today’s call, but the only regret is I could have enjoyed a pure share gain without capping at 160. (205-96)*100 = $10,900.

Summary: I sold options when volatility was high during the crisis and got a nice upfront premium. If Apple shares hovered in the low hundreds or even up to about 160 per share, I would have kept the full premium plus gains on shares. However, since shares zoomed past the strike, I wasn’t able to enjoy the gain past 160. Not a bad outcome overall - could have been worse, right? But just keep in mind with covered calls - there’s no free ride.

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