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Chapter 1: The Preamble to the Apple 10-bagger
Chapter 2: The General Investment Thesis
Chapter 3: Analyzing the Risks
Thursday, August 18, 2011--This article will present a broad overview of the Bullish Cross Apple 10-Bagger investment thesis. There are a lot of moving parts that we will need to spend some time on. For example, in a subsequent piece, we'll discuss the issue of risk assessment and asset allocation.
The issue of exactly how much should one set aside for this investment thesis will be taken up in one of the early chapters. If you have $100,000 set aside to invest in Apple specifically, how much of that $100,000 in capital should one attribute to this particular thesis?
What if you're currently holding the 2013 $400 - $500 call-spread? Should you sell any of that position? What if you're already fully invested in Apple, should you add more to the overall Apple investment or should you sell some of your current position in order to capitalize on this thesis? We'll take a look at all of these issues and more in the upcoming chapters.
For now, we want to be concentrating on the thesis itself and how the trade can potentially unfold. In fact, this chapter will focus solely on how we intend to execute the investment thesis, it will assume that everything will work out to our advantage, and it will have little to no discussion of risk.
In the next piece, we'll discuss what happens if one or more of the trades fail, the level of risk involved in the trade, and how much should be allocated to the thesis given the risk profile of each trade independently and of the thesis as a whole. So let's take a look at how Bullish Cross intends to create a 1,000% gain over the course of the next 15-months -- maybe earlier and maybe even greater gains.
The Bullish Cross Roll-Over Strategy for the October 2011 Expiration
For those who haven't done so already, please read the Bullish Cross Aggressive Roll-Over Strategy posted in the Strategy Room. In fact, please read the material explaining how the Apple Investment arm of Bullish Cross is organized. Everything discussed in this area of the site presumes you understand everything about everything in the entire universe. Well not everything, just everything in the Strategy Room.
So assuming you've read everything in the strategy room, here's how we plan to make 1,000% on Apple. We plan on buying either a September (it will dependent) or October 2011 call-spread with the intention of producing around a 2.5 bagger on our capital. We will then take that capital and roll it into some December 2011 or January 2012 call-spreads for a 2 to 2.5 bagger.
Then we plan to take the capital in January 2012, and depending on how far Apple has moved lower on the second-half weak seasonality, we will roll that capital into the January 2013 $450 - $500 or $450 - $550 call-spreads for a 2-3 bagger. It is all very unclear right now exactly what position we will be taking. I just know that along the line, we will make at least 3 trades and each trade will produce between a 100% and 200% gain. I know this sounds confusing and it should be because we don't have perfect clarity right now on what will end up producing the best possible percentage gain for the lowest possible risk.
I might find that the October $370 - $400 calls are best and will produce a 3-bagger. If we get a 3-bagger followed by two 2-baggers, that's a total of 12x rather than 10x. In fact, at its best, the trade will probably end up producing something closer to 20x. If we could get a 2.5 bagger followed by a 2.5 bagger and then a 3-bagger, that's 18.7x on the trade.
Possible Scenario #1: $380 - $400 October Call-Spread
As of the close of trading today, the October $380 - $400 Call-Spread costs about $8.00 a contract. At the low of the trading session on August 18, I saw those calls trade down to as low as $7.65. If we're able to take a $7.50 entry into the position on this pull-back, and if Apple ends up closing right at around $400 a share at October expiration, that would lead to an almost 2.7 bagger or 167%.
To see how this might work in practice, suppose Oliver sets aside about $100,000 for this trade. In this scenario, Oliver would exit the trade in October with $267,000. From there, we want to be taking a look at some January expiration options. In reality, the first trade is the one that is the most dangerous or risky. If you get through the first trade, then the likelihood that the whole trade will be successful significantly skyrockets given the seasonality.
In the best case scenario, we would close October right at around $405 - $410 a share. In that situation, the January $380 - $400 spread would be trading at around $10.00. This pretty much ensures that we will make the next two-bagger. Apple will very likely close above $400.00 come January 2012 in almost every scenario. Thus, what we really want to see is a close around $400 in October because that will keep the January $380 - $400 spread cheap and affordable.
Assuming this is the case, Oliver would then be able to take his $267,000 and roll it all into the January $380 - $400 spread right at October expiration. If he could buy the January 2012 $380 - $400 spread right at $10.00, and Apple then closes at or above $400 a share in January, Oliver would double his $267,000.
That would put him at $534,000.00 or just about 5x his money already. What's pretty amazing about this trade is that it is surprisingly straight forward for a 5-bagger. We would then take that capital in January, move it to the sidelines, wait for an Apple correction which will inevitably take place and then use that correction to buy the follow October or January expiration.
If it's set up well, you might be able to pull a 3-bagger out of that. Oliver can take his $534,000, roll that into one of these longer dated spreads and turn that into $1.6 million. So in 15-months time, Oliver was able to take $100,000 and become a millionaire with 3 total trades. Three total straight forward trades.
Notice, as the trades unfold, they become increasingly less risky. The most difficult of these trades is definitely this first October trade. But this is the general framework. The reason I put this together now is for the same reason I put together the June investment report when I did.
As Apple's stock price falls on this correction, we might be able to produce the very same excellent trade in a far less risky way. For example, instead of buying the October $380 - $400 spread, we might very well be able to buy the $360 - $380 spread. If we can still get a 2-bagger or better on this trade, then we're in a far less risky situation right? Imagine if we're able to get the $340 - $360 spread at a very depressed price.
If we can get that $340 - $360, then that's when I begin to feel extremely confident that we're going to capitalize on this trade. In fact, to bolster the overall let's all get fucking rich thesis, we can increase our risk exposure by also buying some further out of the money spreads that might produce an additional 3-4x.
If we get tot he point where we can buy the $340 - $360 spread for similar pricing as the $380 - $400 spread today, we could also on top of taking the $340-$360 spread, also buy the $380 - $400 spread with less extra capital. The $380 - $400 spread might yield 3.5x while the $340 - $360 spread ensures our 2-bagger.
So there are a lot of different ways we can really work this trade. For example, here are some of the prices as of the close today. I don't know which one we're going to recommend, but we are going to end up buying one of them for the dedicated Bullish Cross Portfolio. I'm going to tweet and post on Bullish Cross Live when, and which spread we're going to be buying.
October 2011 Apple Call-Spreads (August 18, 2011)
1. $380 - $400 Spread: $8.00
2. $370 - $390 Spread: $9.50
3. $365 - $385 Spread: $10.25
4. $360 - $380 Spread: $10.90
5. $355 - $375 Spread: $12.00
Using Price & Valuation to Reduce Risk
The biggest element going in our favor right now is that we have this correction which is giving us the opportunity to buy Apple at a rather depressed valuation. While valuation impacts Apple less in the shorter-term than it does in the longer-term, as we demonstrated last quarter, Apple tends to value better as it approaches its earnings. At first, I assumed that Apple would report after the October monthly expiration.
But as it happens, because these options expire so late in the month, Apple will probably be reporting its earnings before options expire. And as we demonstrated last quarter, Apple is very likely to react positively to earnings. The only times we ever see a negative reaction on earnings is whenever the stock has already flown to the moon.
Yet, if Apple does fly to the moon ahead of its results, that would be great for the investment thesis. Either we go extremely overbought and Apple is sitting at $440 at earnings and loses ground on the results, or we approach earnings with enough buying interest to push us through huge key levels on earnings. It doesn't really matter which happens. The important point here is that October earnings will probably help us accomplish this investment thesis.
So right now, we want to be thinking about buying a spread that we know Apple will have a very high chance of achieving. The overall chance of this thesis succeeding increases the lower Apple's stock price goes ahead of our entry. Here's why.
We essentially want a 2-bagger on this trade. To get that 2-bagger, we want to be buying the spread at a price that is no higher than $10.00. Right now, the $365 - $385 is trading at $10.25. If that spread pulls back further tomorrow, then all we need for Apple to do on earnings to get our 2-bagger is for the stock to close at $385. A $385 or above close on October earnings, will result in this entire 10-bagger thesis very likely succeeding.
So right now, we have an extremely important decision to make in terms of the timing and pricing of this trade. It doesn't matter which spread we buy, we just want to enter at $10.00 or under. If Apple bottoms tomorrow and starts to run really hard, then we'll buy a higher priced spread. We are far less concerned with betting on volatility than we are on betting on a result.
You have to remember that a call-spread is essentially a bet on a particular outcome while an unhedged call or put option is a bet on rapid price appreciation and volatility. Our bet is relatively unaffected by volatility and relatively unaffected by price appreciation. We just need to make sure that we are able to create a spread that produces a potential of a 2-bagger if Apple closes at or above a certain price at expiration.
So unlike buying a unhedged call, we don't really have to nail the bottom at all. In fact, I would rather know that Apple has bottomed and buy at a higher price, than try to pick a bottom which is not really as relevant when you're buying a spread.
In fact, believe it or not, when you're talking about spreads the $360 - $380 spread could be significantly more risky than the $380 - $400 depending on the environment. If the market is in completely free-fall and there is no bottom in sight, then there is no telling where the selling will end. Apple could end up closing October expiration at $360 in this case resulting in a failure of the trade.
Yet, if the market bottoms and Apple starts to run real hard and hits support near $380.00 a share and now the $380 - $400 are sitting at $10.00, and the coast is clear in the markets, that is a far greater position to be in.
That is not really the case when you're talking about buying calls unhedged. When you're buying unhedged calls, you want to get in ahead of the rapid price appreciation because the gains are highly dependent on this volatility and price increase. With the spread, it doesn't matter where Apple closes at expiration, you should just to be in for a double. So whether that double is at $420 or $380, doesn't really matter to the spread holder.
We'll get into this idea in a lot more detail. For now, this chapter is important in laying out what it is that we are going to be doing over the next week or so. I'm going to be looking for an entry once I feel that the market might be coming to some sort of a bottom or when I feel that the price-range on the spread is so cheap, that the risk is low enough to enter ahead of a resolution in the markets.
The next chapter will take a look at the risks, the amount we're going to want to allocate to this thesis, and the multiple ways that we can reduce that risk. We're also going to discuss the issues that can derail this thesis and how to recover if the first trade fails. You can still end up making a good 500% gain even if the first trade ends up failing. Stay tuned.