My First Option Trade – AAPL Jan’11 270/280 Bull Call Spread

Apple DollarsIn 2010, after much paper trading, I finally embarked on a campaign to trade options on my cash account. Over the next several weeks, I plan to report my trades, their results and what lessons, if any, I learned. Whether or not you accept the veracity of these reports does not concern me — these trades illustrate a lot of the things I did wrong, and should be instructive.

June 29, 2010 – Jim Cramer was projecting a price target of $300 for AAPL, while other analysts were raising their targets to levels like $325. Things looked pretty bullish for Apple, and I thought the back-to-school and the holiday season would bring good news to the company. Apple stock was hovering around $256. Out of the money calls are cheaper than in the money calls, and I wanted to give the trade enough time to develop. Hence I chose call strikes above the then current bid, and the first expiration after the holidays. I paid 29.44 for the Jan 11 270 call on AAPL, and I sold the Jan 11 280 call for 24.94. My debit was 4.5.

I bought ONE spread, and was charged about $15 in commission. Assuming I’d get charged another $15 to close out the spread, I calculated my break-even to be 4.8.

In other words, on June 29, 2010, I committed $480 for this trade, and my profit and loss graph looked like this:

AAPL Jan 11 270/280 bull call spread

P&L Graph Courtesy

The most I could lose was $450 + $30 round-trip commissions. If AAPL were to close at $274.50 on expiration, I would break even. And if it closed at $280 or better, I would realize the maximum possible profit on the trade $550.

July and August were tough – AAPL price dipped below $240, and the bid on this spread suffered too. But, as I anticipated, September proved to be pretty good for AAPL.

September 20, 2010 – With AAPL climbing, and the bid on this spread at 5.8, I decided to sell on the morning of the 20th.  AAPL did close above 280 that day, and in the end I did probably leave about $450 on the table. But I made a tidy profit of $100 on a $480 investment in three months, so I was happy.

I attribute the “success” of this trade to beginner’s luck.

What I did wrong:

  1. I was way too cautious with choosing a spread that would expire in almost 6 months. There were two premises to this trade: the back-to-school season would be good to AAPL and the holiday season would be good. That should have translated to two trades: one that would expire in October 2010; and another that would start in October or November and expire in January 2011.
  2. I sold too soon. With a ten dollar spread between strikes, and AAPL on an upswing (through the short strike of 280 on the day I sold, as it turns out), I realize I lost out on this trade — I made $100 profit, when I could have made four or five times that.
  3. I traded this in the morning. In “Trading for a Living”, Elder says that  amateurs tend to trade at the open while professionals trade near the close. By trading in the morning, or even setting limit orders after the close, I am reacting to the previous day’s developments and trends; by trading near the close, pros are one step ahead of amateurs and reacting to that day’s developments and trends. In addition, pros actually set themselves up to take advantage of amateurs’ reactions the next day. By trading in the morning, I am clearly an amateur.
  4. I did NOT do a thorough analysis of “the Greeks” on this trade. Had I done that, I might have found a trade that stacked the deck more in my favor.

What I did right:

  1. I had a good thesis (AAPL would do well during the back-to-school season …) that was substantiated both by fundamentals (low PEG, good cash-flow, high book value, etc.) and by analysts.

On the whole, I am happy with this trade. The lesson I learned from it, “Trade at the close, not the open”, is one I wish I had learned back in June 2010, rather than now upon review, because it would have prevented some of my later losses. I donated the profit earned to a friend who was running for State Representative but … that’s another story.

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