New Approach with QQQ and AAPL

I’ve been eyeing puts on AAPL again for the past few days.  If I had stuck with my strategy from last year and kept repeating it, I would have made up for my losses.  Instead, I backed off and waited for AAPL to settle down.  I don’t think it has settled yet and so I came up with a new plan.

I have been trying to figure out a ratio spread on AAPL where I could go long a put spread and pay for it by selling a far out of the money naked put.  There are plenty of combinations that looked attractive at first, but none seemed worth the risk of AAPL’s volatility.  It could rocket over $500 or be below $335 within a month.  The out of the money naked put leg would lose money faster than the at-to-the-money put spread would on a decline.  If AAPL dropped quickly in the near-term, I’d have to consider dumping my position early for a loss again.

I opted to combine my AAPL put spread with QQQ to reduce my overall risk.  QQQ is volatile enough to have decent premiums.  If QQQ tanks, it will likely mean that AAPL is falling too since it is such a large component of the ETF.  Ideally, the next month and a half will be one of those periods where AAPL falls, but QQQ manages to gain or at least stay flat.  If so, I’ll “win” on both sides.

While AAPL was trading at $424.90, I bought two AAPL April $410 puts for $11.13 and sold two AAPL April $405 puts for $9.43 each.  I paid $343.11 including $3.11 in commission.  As soon as that hit, I sent my market order on QQQ.  While QQQ was trading at $68.44, I sold two QQQ April $69 naked puts for $1.60 each and received $318.46 after commission.  That’s a total cost for the combined orders of only $24.66.  I doubt this will be my cost in the end since it has different moving parts.  My QQQ puts are already in the money and have a delta of -59.  So, every tick lower is going to be felt right away.  The APPL put spread won’t react as quickly since it’s farther out of the money and has a very low combined delta.  The $405 put has a delta of -0.30 and the $410 put has a delta of -0.34.  I’m banking on AAPL moving a lot quicker south than QQQ does or having them both rise and I lose $24.66 as none of them finishes in the money.  I could cut into that little loss by selling the long leg of the AAPL spread if the stock reverses course big.  I’m not planning on that, but it’s out there as a possibility.

I could gain $656.89 from the put spread if AAPL loses ground like I’m planning for it to.  The QQQ probably won’t let me get away with that much without taking some back through losses on my naked puts.  I’m not worried about big QQQ losses based on the following math.  I’ve received $318.46 from the QQQ naked puts already.  If assigned, my cost will be $67.41 ($69 – $1.59).  AAPL will need to move lower for QQQ to fall lower than that (in most situations).  If I can get a full profit on my AAPL spread, I’ll be able to reduce my QQQ cost per share another $3.28 (based on combining these trades).  After deducting the AAPL profits, my QQQ cost per share would be $64.13 ($67.41 – $3.28), well below the year-to-date low of $65.97 and even below the 2012 closing price of $65.13.

It crossed my mind as I was considering this trade that I had no QQQ exposure.  I wasn’t looking for a way to open a QQQ position, but it could end up that way.  QQQ can drop 1.51% before I take a loss on that leg of the trade.  If it climbs 0.82%, I’ll have a 2.36% gain (19.2% annualized).  The QQQ leg isn’t risky based on the assumption that QQQ can pull out at least a 6% gain this year.  I might be assigned the shares in April, but if I’m patient, it should pay off.