2016 has so far been disappointing for the bulls, mostly because traders are selling market bounces instead of buying dips. This makes finding successful entry points into long stock positions difficult.
But that’s no excuse to avoid the whole market.
Today, I want to show you how I can profit from a recovery in Amazon.com, Inc. (AMZN) stock for zero cost — using Apple Inc. (AAPL) stock, no less.
We face so many uncertainties this year, but I’m certain of a few things. For example, I know Apple stock is closer to a bottom than to the start of another big drop from here. So I am confident I can sell puts in AAPL that will be 100% successful this year.
I also am confident that when markets stabilize, Amazon stock will lead the bounce higher. Under the leadership of its CEO Jeff Bezos, AMZN has been a longtime leader in stock price appreciation, wowing investors and destroying those who short it.
Click to Enlarge Technically, both Apple and Amazon stock could go lower, but my strategy allows me to be long in this uncertain market for no out-of-pocket expense. The worst-case scenario is that I lose money from being long AAPL stock at $70 … but that would require an additional 28% drop from current levels.
Trading Apple and Amazon Stock
I want to use a pair trade to take advantage of the value currently found in Apple stock. I’ll use AAPL options to generate income, which I will use to finance a long position in Amazon stock. Also, options are time-sensitive, so I want to set enough time on my trade to better manage the risk.
This strategy is made up of two trades.
- Trade #1: I sell AAPL Jan 2017 $70 put and collect $2.70 per contract. This opens the downside risk in AAPL but puts cash in my account. I usually don’t like selling naked puts, but since the Apple stock price is well off the recent highs, I am willing to be put the stock at $70 should it collapse. I can also buy a cheap Feb 2016 $70 strike put for 11 cents per contract to help me wait out fears from China and oil headlines.
- Trade #2: I want to go long AMZN and buy the Mar 2016 $640/$645 debit call spread. This will cost me about $2 per contract. If Amazon stock rises through both legs before time expires, I stand to more than double my money. But since I am collecting $2.70 per contract for the AAPL trade, any profit is pure profit. I can even afford to buy another bullish AMZN debit call spread. The Feb 12 $655/$657.50 spread costs 80 cents per contract and would triple my money if AMZN bounces higher past $658.
China and crude oil headlines are likely to linger as sources of market jitters and could damage my trade. Fed funds rate hikes — likely starting in March — could lessen my odds of success. But if my thesis is correct, I profit on Amazon stock price appreciation for free. If I’m wrong, I may get to buy AAPL for a 28% discount from these levels.
While I can’t call the actual bottom in Apple stock, I do believe that after a recent 30% price cut, AAPL presents an enticing value. I believe that it would take a serious market-wide correction shares to fall lower than $70 per share. AAPL has $35 in cash per share. At current prices, it reminds me of buying a desired house that has been recently reduced by 30%, and has a safe inside with cash worth about 40% of the entire house value. Naturally, Apple would be even more attractive at $70.
Click to Enlarge Although selling naked puts on AAPL creates income out of thin air, it also can be a risky bullish bet. I risk being put Apple stock at the strike price of the put sold.
I can limit such risk and reduce the margin requirement by substituting and selling the Jan 2017 $75/$70 credit put spread for 99 cents per contract instead.
Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities.
