NEW YORK (TheStreet) - How do you eat an elephant? The same way you eat an apple -- one bite at a time.
For many, the idea of buying Apple (AAPL) may seem the same as trying to eat an elephant. With a price tag over $56,000 for a single lot of 100 shares, it's easy to understand why. Even if you're an Apple perma-bull, diversification is lost when a $120,000 portfolio is half Apple.
Apple has just about everything a long-term investor wants -- dividend, brand, financial strength, leadership and future outlook. I believe the next stop on the Apple train is $600. You can read how I arrived at my conclusions here, here, and here. The problem for many investors is the oversized per-share price. I cringe each time I'm told someone bought call options because 100 shares were too much.
I'm going to demonstrate how you can create and hedge your position using the same strategies as the largest Wall Street hedge funds while using a more modest portfolio. The first step is to buy Apple in what's known as an "odd-lot". An odd-lot is a trade that isn't a multiple of 100 shares. For some this comes as a surprise, but there isn't a rule that says you have to buy 100 shares at a time.
For example, almost all brokers will allow you to buy 10 or 20 shares just as easy as buying a full 100 shares. Nothing actually changes except in your broker's statement, you have maybe 23 shares instead of the usual multiples of 100. In fact, if we use Amazon (AMZN) as another example, buying 10 Amazon shares at $380 is no different from your portfolio's point of view than buying 100 shares of Voxeljet (VJET) at $38.
The problem with odd-lots in the past is it was difficult to hedge with options. In order to sell covered calls in the past you needed to own at least 100 shares of the underlying. The standard size contract for exchange traded options has always been 100 shares. This year, the Chicago Board Options Exchange (CBOE) introduced option contracts sized at 10 shares to fill a need for hedging strategies for super-sized share prices.
Apple, Amazon, Google (GOOG), SPDR Gold Trust (GLD), and SPDR S&P 500 (SPY) have 10 share option contracts available. If you want to ride the daily new market highs train, but don't want to outlay $17800 to buy 100 shares, you can. $1,780 can buy 10 shares, and now you can sell a covered call or buy a put to protect your investment against a market crash.
Of course, you're not limited to covered calls and puts, you can also get fancy and create calendar spreads, bull/bear credit/debit spreads, and every other possible combination that is available to 100 share contracts.
This leads me to one of my favorite ways options allow me to create a position, the credit spread. In its most common and basic form, a credit spread is a combination of a long and short option with different strike prices but using the same stock and expiration date. With a credit spread, the long option is further out-of-the-money than the short option contract, resulting in a net gain of premium.
For example, a bull credit spread for Apple that I like is the February $540 /$510 put spread (credit spread). I can sell the $540 February put for about $22.50 and buy as a hedge the $510 put for about $11.50 for a net credit of $11. Previously, this spread would have a total risk of $1900 and a potential gain of $1,100.
With the new CBOE's mini options, I can create the position and only risk a total of $190 and potentially gain as much as $110. Because I'm bearish with Amazon, I will use it as my bear example and continue to use a credit spread. For a bear credit spread, we use call options instead of puts. I like the February $410/$440 credit spread. We can sell the $410 call for about $13.50 and buy as a hedge the $440 call for about $6.25 for a net positive premium of $7.25.
Using 100 share traditional contracts results in a maximum loss potential of $2,275 ($410 - $440 = $30 minus the premium of $7.25 = $22.75 times 100 shares = $2,275). If $2275 is too much to risk even though you're Amazon bearish, a mini contract total risk is only $227.50, with a potential gain of $72.50.
Making a full circle back to Apple, buying calls is no longer the only strategy available to modest retail investors that want to gain exposure, but also sleep at night knowing they have limited risk. By using mini contracts, you can more precisely dial-in your risk to fit your investment objectives.
At the time of publication the author had no position in any of the stocks mentioned.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.