This column originally appeared on Real Money at 12:30 p.m. ET on March 15.
Today's market environment provides an excellent backdrop for taking on an options trade that, in many cases, results in an almost zero cost to put on the trade. Yes, that means that the net cost of buying the option can sometimes be zilch or, in some cases, you are getting paid to hold the options.
The trade is actually quite simple in construct -- but, as with anything I advocate, it needs to be intelligently executed. The two-legged trade simply involves buying a call option at one exercise price and selling a put with the same expiration date at a lower exercise price. What makes this particular trade so appealing today is that U.S. equities appear to be in an uptrend -- and, as long as the economy continues to show sprouting signs of improvement, any pullback could provide an opportunity to buy an attractive business at a good price. This trade accomplishes both.
Let's look at the world's most successful and admired company today: Apple (AAPL). Waiting for shares to post a quick pullback for a buy entry has been a painful exercise. I don't follow the stock much, but I do check it once a week or so purely for amusement's sake, marveling at how high the shares have been able to go. It seemed just last week they were trading for $500. By the end of this week, if not today, they could pass the $600 milestone. If the new iPad sales continue to surge -- and the company has already sold out of the first batch -- the stock price will likely follow suit.Those interested in betting on Apple can put on the following trade. Rather than buy the shares, you could purchase the January 2013 $700 calls for $31. At the same time, you can sell the January 2013 $495 put for about $31, for a net cost of zero (plus applicable commissions, of course). If Apple shares breach $700 between now and expiration, you'll be making a profit. Even if shares sit at $710 in January, you'll have made a profit, because your put sale will expire worthless. That would net you $31 per contract while your call option will have an intrinsic value of $10, or a loss of $21 on the call. The gain from the put, less the loss from the call, nets out to a gain of $10. If you'd merely bought the call, shares would have had to trade above $731 in order for the options to have been profitable. Of course, the put exposure does obligate you to take ownership of Apple at $500 a share, so you'd have to be comfortable owning shares at that price.
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