AAPL: How to Protect Your Gains in Apple Stock Like a Pro

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It’s been a great month for Apple Inc. (NASDAQ:AAPL). The tech giant has left the market in its dust, and Apple stock has jumped more than 20% off the launch pad since late January.

The surge in returns has some investors singing AAPL’s praises and others scratching their head as to whether they want to lock in profits — especially now that it looks like Apple stock might have reached a near-term top.

From our perspective, this is exactly the type of situation where hedging Apple’s recent gains makes sense.

aapl stock

That’s right, you can hedge a position in AAPL in a way that allows you to continue holding the shares while protecting potential downside after a run like we’ve seen over the last month.

First the reasons to protect your recent gains:

  • Reversion to the mean: It’s a fancy way of saying what goes up should come down. In this case, we’re referring to the outperformance of AAPL. Historically, the stock tends to give up some of its short-term gains after a stellar run. A great example of this was the 13% decline in shares after the stock peaked in late November.
  • Technically overbought: Chart watchers are eying Apple stock as being overbought as the stock’s RSI readings recently moved above 70. Historically, AAPL tends to see sharp retracements after similar overbought readings.
  • Recent activity in the options pits: Activity has favored calls by a ratio of more than 2-to-1, suggesting that the stock has also become overbought from a sentiment perspective.

Given the reasonable argument for a short-term top in AAPL, investors are faced with choosing one of a few options:

  • Do nothing, ride out any losses and wait for AAPL to head toward new highs again: We call this “white-knuckling a trade” — that’s because investors that choose this route often wind up selling shares anyway when the stock drops because they’re not 100% confident in their choice when things get ugly. (And most of the time, they end up selling shares at the wrong time.)
  • Sell shares at current price and lock in the recent profits: This approach is simple and guaranteed in that you know you won’t see any downside, but what about the potential upside if the stock only drops a few percent and then takes off again? Are you willing to buy them back higher? Usually the answer is “no.”
  • Hold the shares with some protection similar to a term insurance policy: This is what the pros tend to do to avoid getting hit by a pullback.

Let’s take a closer look at option No. 3

Let’s say that we believe Apple stock could retrace to the $110 level again. In this situation, protecting shares in a portfolio with a short-term put options is easy and makes a lot of sense.

For our example, let’s say that we own 100 shares of AAPL. Currently, the AAPL April $120 puts (which expire on April 17) are trading for about $123 a contract. To “protect” our recent gains, we would purchase one of these options (each contract “covers” 100 shares of AAPL), spending about $123, or under 1% of the value of our 100 shares.

After purchasing the shares, the position is considered “hedged,” meaning that drops in AAPL share prices will result in an increase in value of the put options that has been purchased. So what do we do now? Let’s look at three scenarios:

  • AAPL pulls back to our target of $110 before expiration: Our protective put will be worth a minimum of $1,000. Since this is our target price, we would close the protective put and either bank the insurance money or use it to buy nine more shares of AAPL at $110. This would mean that the next time AAPL hit $130, our account would be worth an extra $1,170 as a result of reinvesting our proceeds for the hedge back into AAPL.
  • AAPL pulls back only slightly over the next two months: Our hedge will expire worthless on April 17 and our position will be worth $123 less as a result — a very small relative cost for not having to worry about a $110 print on AAPL.
  • AAPL shares surge to $140 over the next two months: Relax. Unlike the scenario where we sold the shares to lock in profits, we still own our shares, which are now worth $14,000 instead of $13,000. Of course, our hedge expires worthless, meaning our gain was actually $877 instead of $1,000 … but remember you banked that gain while not having to worry about things like volatility and surprises.

Contrary to popular belief, hedging a position like AAPL is easier than thought when using simple option strategies. Of course, you’ll have to have an options approved account and the basic knowledge of how options work to employ the strategy, but a little bit of time is worth the extra sleep you’ll get knowing you’re hard earned gains are covered.

As of this writing, Johnson Research Group did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/02/aapl-apple-stock-options-protect-profits/.

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