Chapter 2: The General Investment Thesis

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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.

55 responses to “Chapter 2: The General Investment Thesis

  1. Pingback: Chapter 2: The General Thesis underlying The Bullish Cross Apple 10-Bagger | Bullish Cross

  2. This itself is thrilling :-)

  3. This reminds me of when 24 was on Fox 5. After every episode, you couldn’t wait for the next one to watch.
    Bring it on, Andy!

  4. I’ve learnt a heck of a lot in the past 6 weeks, and hv been sketching out a similar plan since the 1st leg down. You’ve alluded to this in past publications and I’ve tried to apply the framework. I actually put in an order to buy the $380-400 Jan 12 spread at <$8 during the 1st leg down but pulled it cos I chickened out (chose Jan expiry cos at the time Oct looked relatively more risky per one of your posts). With your roadmap, I feel greater confidence knowing I'm on the right path, and now have your assistance in getting the execution right. What greatly helped is your point abt setting return targets, eg. anything to achieve 2x is good, and also how best to reduce risk doing it, eg where possible get a lower entry point after there's a bit more clarity about where a "floor" for AAPL might be. Great stuff. Thanks Andy !

  5. I quote your statement from above: “Our bet is relatively unaffected by volatility and relatively unaffected by price appreciation.”

    I think you should be very careful with this statement it could really mislead an investor not familiar with the dynamic of a vertical spread! Not to mention that without price appreciation the bet doesn’t pay I would not call that “relatively unaffected”!


    If one was however to assign probability to ea event it might be 1/2 x 1/2 x 1/2 (as one needs to get the timing perfectly right). That’s 12% for a 1o bagger or more granted! I still like the play but’s its full of risk a bit like flipping a coin 3x for double or noting ea time.

    I think we’ll both agree that there is going to be a huge run up before the next earnings: surely there must be a better play than just a 2x?

    I just wish I had read your blog when u advised the 400-500 spread. That was a gem!!

    • AppleGold — So a few big issues stand out in this comment. First, when you say “it could really mislead an investor not familiar with the dynamic of a vertical spread,” I hope you realize that everyone who’s reading this has not only been warned that they should know how a call-spread works but that there is actual pre-requisite material that is required to even understand this material. We’ve hammered that home enough times.

      Secondly, you’re pulling that sentence completely out of context. Who just reads only one sentence in an entire article?

      “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.”

      Notice that right after before we say this we explain that a call-spread is a bet on an outcome while an unhedged position is more of a bet specifically on price appreciation and volatility. For example, yesterday anyone who bought the September $117 puts on the SPY wasn’t really betting that the SPY would be below $117 at expiration. They were betting that the SPY was going to tank very soon and that volatility was going to skyrocket. A lot of people are up 100% today and probably took profits.

      On a spread, you’re not making that bet. You’re more focused on capitalizing at expiration on an outcome i.e. that the SPY will be above a particular price. You’re gains derive from the outcome. While the Spread might appreciation on the volatility, the appreciation won’t be that significant until you get closer to expiration. But everyone who’s reading this, should know this. Which now that I think about it and given your comment, I might require an exam for entrance to these types of pages.


      Now as to your comment about probability, you can’t assign a 50% chance. It’s not a coin flip. It might be a coin flip for people who don’t know what they’re doing, but it is certainly not a coin flip for me. I would not be invested in the market if it was a mere coin flip. There’s a lot more to it than assigning a 50% probability. In fact, there is far greater than a 12% chance of success. If you take this trade 10 times, you’re going to succeed far many more times than just 1/10.

      I would NEVER advocate such a trade if the probability was 12%!

      “I still like the play but’s its full of risk a bit like flipping a coin 3x for double or noting ea time.” Give me an opportunity to lay out those risks. The way you lay this out, you make it sound like the entire market structure is just gambling.

      If everything is 50-50, then everyone should just cancel their subscription, take their cash out of the market and go to vegas. It’s the same thing and probably more enjoyable.

      Think about it this way. To people who don’t really understand the market all too well, they might have assigned a probability of a 1000 point relief rally on the Dow as being 50-50. But to those who run the analysis know that probability was closer to 85 – 95% given the past history. That’s why we hammered that home, and that’s why we hammered home that today would happen.

      So again, it is presumed that everyone here is advanced enough to know what a call-spread is and how a call-spread functions. I think there’s a good chance that I might be requiring an exam before gaining access to this type of material. Contemplating that in our next membership software.

    • Notice this part specifically:

      “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 everyone about everything in the entire universe. Well not everything, just everything in the Strategy Room.”

      • Andy, hats off to you; you have so much patience and that’s a great trait for an investor.
        The “exam” idea is great :-)

        There is hell and heaven difference between 50% and 85% risks (I understand 85% is even your most conservative estimate).

    • With all due respect I think your math to reach 12% success rate is way off. You give no credit for what we know at the completion of each trade as well as the fact that the 2nd and 3rd trades will be well higher than 50% that said Andy is right to emphasize that there is no such thing as a sure fire 10 bagger. It’s important to keep everyone’s feet firmly planted on the ground.

  6. Cue the Mission Impossible theme song music…awesome!!

    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…Apple could end up closing October expiration at $360 in this case resulting in a failure of the trade.

    Lets assume $7.50 for 380/400, so 20/7.5=2.67-1=1:1.67 risk/reward. Assume $10 for 360/380 = vs 20/10=2-1= 1:1 risk/reward. So it seems you are saying the 360/380s are significantly more risky if you are basing it purely on financial risk. But clearly if the 360/380’s fail, the 380/400’s fail. So properly anticipating the marketplace climate, as you mentioned, is another portion of the risk that cannot unfortunately be measured in the traditional risk/reward calculation.

    • You can’t just calculate it. The risk to which I am referring is market risk. Notice that in the article I repeatedly state that we’re working on the risk assessment part of this trade in a separate piece. But I keep getting all of these comments on risk. Everyone should wait for the risk article.

  7. My point about the 3x coin flip was not to say that’s it’s a 50/50 thats very hard to estimate (although the spread paying 2 to 1 would indeed imply this). The point is that whatever the odds its a combination of 3 event! Not only that but these 3 event may not pay out 2x ea time you might collect 1.5x even if you enter below 10 on a 20 spread. Apologies for picking your sentence out of context you work so hard and write so much its not fair.

    As far as the exam: you’ll know that all the brokers ask their customers for experience trading these products so your fail-safe is there already. You’re giving us shooting advice but the gun is provided by the brokers 😉

    Thank you again for all you knowledge and vision.

    • That

    • The probabilities of the three events aren’t independent in the probabilistic sense.

      Since we’re dealing with spreads, the question is where will aapl be at the expirations. The probability that aapl > 400 at Jan 2012 expiration increases if, for example, aapl is at 400 by Oct expiration rather than at 360. That’s why the risk is front-loaded, and the tough call, given this market, is where will aapl be in Oct.

  8. Great chapter and preamble. We are all adults here. We know the risks. If you don’t, Please re-read the material. I think bullish cross has made the risks clear in it’s volume after volume of writings. This is adult swim people….. Good stuff Andy. This is what I am happily paying for!!! Look forward to more chapters and verse…

  9. AAPLGold: one of the errors is you are trying to quantity the risk and you can’t because it is not Apple specific but rather subject to macro issues. And a 2x return does not imply inherent odds in a spread but rather the combination of factors such as stock price, time, and volatility when bought. Look at the quality and depth of writing- don’t doubt.
    I look forward to future chapters.

  10. Shorted the Spy and almost took those puts yesterday. I just consume the excellent knowledge and roll with it, thanks Z.

  11. Great article Andy !
    You have taken so many steps to make us aware what risks are and how we make our trades based on it.
    This is making us not only better investors financially but also more analytical as we look at situations.
    Looking forward to many more of your awesome articles.

    Keep on cranking…


  12. Hi Andy,
    While Apple is very seductive, I wonder if CAT doesn’t provide a safer and easier play for a 7-8x bagger. You previously mentioned that CAT is going to $200 in the next two years. Going by that thesis, a $100-$150 spread on Jan 13 CAT costs $6.45 today. Isn’t that a pretty nice 7 bagger with minimal supervision? Would really love an article on CAT since it’s part of the BC portfolio.

    • So I feel less confident in the $100 – $150 spread on CAT than I do on Apple. That isn’t to say that I don’t feel confident in CAT. Yet, right now when it comes to CAT it’s probably going to get hammered a little bit. The reason for this is simple. CAT is a cyclical stock that is dependent on the business cycle. So it’s not going to perform well in a recession. While the company might perform very well, people view it as too cyclical to hold in their portfolios. So the stock will perform poorly so long as the majority of the market thinks we’re entering a recession.

      I dont’ think we are going to see a double-dip. So I’m going to use the incoming weakness in CAT to take some good long-term positions. I think it’s too premature right now. But it’s something worth considering. If you can get that spread at $5.00, that would be pretty fucking good. I’m not going to lie. How in the hell is that spread worth $6.45??

    • how about a cheapie 16 bagger CAT Jan13 140/150 for $0.61?

    • You know what. After this weekend, and maybe on Sunday night I’ll put together an introductory article. I have a research assistant who can pull the recent data for me. You see all of those Apple charts that I have? Believe it or not, I have that for like 12 companies including CAT.

      I just haven’t updated them recently i.e. past 2 quarters. I’ll see if my assistant can do that for me and then I’ll be able to write the article. The plan all along was to get all of that information up on the site.

      Instead of it saying “Apple” in the navigation bar it will say Stocks. Apple would be just 1-tab in that section of the site. We would run the same format and analysis for all of these other companies along with Apple. We will definitely get there. Soon I’ll be hiring someone else to cover Apple while I take on the other companies. Obviously, I’m still going to be covering Apple and the estimates will be Bullish Cross estimates. But instead of writing the articles, I would have the other writer cover it in the same way I would.

      I was thinking of bringing on Turely Muller — a close friend of mine — or maybe Horace Dediu of Asymco to take over the Apple part of Bullish Cross. There are a lot of very good analysts who can do this. It’s just all about the format and timing. You have me to make all of the best timing decisions and run the valuation but the estimates etc can easily be run by Dediu or Turley Muller. I’ll probably pitch the idea to them soon.

      Because I think the format we have here is good. We just need to extend it to so many other companies.

      • Inspired by Coopie’s “cheapie” strategy, here is my first contribution to Bullish Cross! 😀

        Bullish Cross Initiates Buy Recommendation for CAT $100-$110 Jan 2013 Spread
        By Fake Andy Zaky

        Everyone needs to read this. Today we are taking our second position in CAT. The main reason we are recommending the $100-$110 Jan 2013 call spread is because it keeps open the potential for very significant over-sized gains while preserving a relatively low risk profile. CAT is very unlikely to trade at under $100 a share come the October – November 2012 timeframe. But if this were to happen notwithstanding, the position would at the very least break-even. With 3-months left until expiration, if CAT is trading in the low $100, the spread would likely be trading at cost or higher. Here’s why.

        At today’s market price, the cost of the spread itself is only $2.50. Here comes the central value and general genius of this investment report. If we look at just inside the money calls that have 3-months left until expiration — that would be November 11, 2011 $82.5 call options — they are priced at $8.15 as of Thursday’s closing price. As for the $110 calls that we short — they would be worth about $4.7. How do we know this? Well look for the options that are 10% most expensive than the just in the money $82.5 calls. That would be the November $90 calls which are currently trading at $4.7. So assuming CAT is trading at a mere $100 come October 2012, the spread we bought for $2.5 would still be worth $8.15 – $4.7 = $3.45, or just short of a double.

        To summarize, if CAT performs as we expect and close above $110 by January, you take home a easy 4 bagger. If CAT fails to materialize and meanders in the $100 range three months prior to expiration, you should break even in the worst case, or more likely, exit with a decent profit.

        In an upcoming article, the real Andy Zaky will look at why the above thesis is fatally flawed. Hint: it has to do with CAT’s valuation and its cyclical business.

        -Fake Andy Zaky

      • Andy, I am a huge fan of Horace Dediu. Your styles are different but both incredibly powerful. Together you guys would be like Shaq and Kobe.

      • Andy, I have been following both you and Horace for some time. Wow, it would be a pretty powerful team!!

      • this sounds great. with an all star team like this and some capital, i have no doubts you could take on S.A. or any other financial organization.

  13. Andy,
    Thanks for all your hard work. It’s much appreciated.
    I haven’t found any information anywhere on tax aspects of these trades. Have you covered that in any articles? When you do a “rollover” does that mean that you just sell the call spread that is expiring and buy a new one that’s dated further out? Does that make the first transaction a taxable event in 2011? And would that mean you would owe taxes on it as of April 2012 (or earlier actually)? I ask this because if the money that you make in the trade is taxable it leaves you less money to roll into the next trade. Also… is there a difference in a short term gain versus a long term gain? For instance 2013 leaps, because they are more than a year out, I think would be long term.
    Disclaimer- I am not an accountant nor do I expect Andy to be one. I was just wondering if there is a difference in the gain due to the effect of taxes. I’m not really familiar with the mechanics of rolling over options. If rolling over an option is just exchanging one option for another perhaps “a rollover” doesn’t create a taxable event.
    Maybe this is not even a topic for discussion here as everyones situation is different and we should all just check with our own accountants and not discuss it here.I don’t mean to put any extra weight on you Andy. You have enough to do already. Maybe it’s better if we all figure out our own situations. In that case I’m jut throwing it out there as something to consider.
    I imagine some people here are working with individual retirement accounts so their situation would be different also.

    • yumski — when I say roll-over I actually just mean rolling your money into the next expiration. So at October expiration, you just sell the spread and take that capital and move it into the January expiration. In January, you buy the 2013 expiration. I’m not an expert in taxes. I would ask an accountant on this. I know there is something called the wash sale adjusted rule which basically treats the sale and repurchase of an asset as if you never sold the asset from a tax perspective if you do this within 30-days. I don’t think it applies to options. Actually I’m pretty sure it doesn’t. But I’m not an expert on this so I can easily be wrong.

      But yes. They are taxable events. As such, I think you’re fine rolling over you October spread into January expiration, but I think what you need to look out for is how deep in the money that spread is on December 31. For example, if you’re up 100% on the October spread, and the January spread looks like it’s too close to call, it might be worth dumping in December because you don’t want to be stuck in a situation where you sell in January for a loss on the January spread and yet you have huge gains on the October spread. Because you still owe taxes on the October spread and you aren’t able to use the January losses as an off-set. That’s how I understand the situation. But again, not an expert and I could be wrong.

    • yumski, there is so much to taxation issues–I really suggest you need to read up as much as you can and consult a good CPA or tax attorney…there is no way any response can cover all points and you don’t want to trust anyone except your own judgment in the end.
      I mean that w/ good intentions. FWIW…for taxation on option spreads (other option strategies like straddles/strangles have additional rules), in the US (IRS rules), there are a few rules to help guide:

      1. Simplify by breaking into parts
      a) A rollover or roll forward is just 2 sets of transactions (e.g. close out an open spread, then open up a new one) — break these up and treat each one individually. So, if on Jan 10, 2012, you have an open spread expiring later in Jan 2012, and you end up closing it and then opening up a Jan 2013 spread, you have 2 separate spread transactions, each by definition composed of 2 legs
      b) break each spread into its legs and evaluate each individually for tax purposes (the IRS has no idea what your pairing of spreads are) — you have a short and a long leg w/ each vertical spread. Each leg has its buy/sell price, open/close dates, cost basis/proceeds, etc.
      2. dates
      a) there is an opening date (when you buy or sell to open, depending if it’s long or short)
      b) there is a closing date (when you sell or buy to close/cover, depending if it’s long or short)
      i) the closing date is the date you sell or close your option position if you do it before expiration
      ii) if you hold until expiration and the options are OTM and expire worthless, the expiration date is the closing date
      iii) NOTE: if you exercise or get assigned, this becomes a stock transaction and things change. Read this line again.
      c) the *year* of your closing date determines when you have tax liability. For example, any play with Oct 2011 spreads will be taxable in 2011. Any positions still open as of Dec 31, 2011 including Jan 2012 options will be taxed in 2012.
      3. ST vs LT
      a) the time difference b/t your open and close dates will determine your ST vs LT status. It means that any new (from today onward) positions opened for Oct 2011 expiration and Jan 2012 expiration will be ST no matter what (we are 1yr, LT capital gains applies, say 15% in the US. ST gains are whatever your income tax bracket is, say 30+%
      c) the gains are clearly the diff b/t your cost basis (buy price) and your proceeds (sell price)
      d) if an option expires worthless, its cost basis is ZERO (for a sold option) or its proceeds is ZERO (for a bought option) — reflects reality
      e) all basis/proceed #s include commissions/fees (i.e. are reduced or increased by that) — go by the net #s that show in your account
      4. Short position notes
      a) short legs have the order of date/price switched up, but tax software and IRS forms are all ready for that. i.e. sell to open option ABC on Aug 19, 2011 (sell date is Aug 19, 2011), and buy to close on Sept 30, 2011 (buy date)

      Easy enough so far? No, it’s not. Never get cocky w/ the leech that is our IRS. Otherwise we wouldn’t have such a thick tax code and huge special interest lobbying $$ by tax attorneys/accountants/big-N firms/tax software firms/etc, but I digress. All of the above applies to *option* transactions where an option is bought and sold. But if you exercise your option or the other party assigns to you…it becomes a stock transaction. Which has a lot of the same principles but is more complicated in terms of cost basis and timeframes.

      5. Exercise and Assignment will change your cost basis/proceeds and your dates — think in terms of stock, not options
      Example #1: on Aug 19, you buy Oct 2011 AAPL 360 call @ $28.75. For whatever reason, you choose to exercise on Sep 22, 2011. It’s now a stock transaction.
      a) Cost basis of your AAPL stock = $360 (cost of stock) – commissions/fees – $28.75 (cost of option)
      b) Buy date = Sep 22, 2011 (option date purchase date irrelevant) => obvious implications on ST/LT status
      c) Close date and proceeds depends on when you sell the stock. Sell it on Oct 27, 2012, and you have LT gains/losses

      Example #2: on Aug 19, you *sell* Oct 2011 AAPL 360 call @ $28.75 for some bad reason. On Oct expiration, you are assigned b/c AAPL is at $400. You’re obligated to sell AAPL stock for $360 to a counterparty
      a) Proceeds for you = $360 (cost of stock) – commissions/fees – $28.75 (cost of option)
      b) Sales date = assignment date
      c) Your cost basis and purchase date depends on how you obtain that stock to cover assignment. If you already had stock, then you go buy the dates you acquired stock. If you have to purchase stock or short stock, then those determine your dates/price. In the latter case, you likely are in ST status (w/in days).

      6) Wash sales apply to getting out and back into the same position < 30days. Just means the IRS is willing to ignore the transaction since you're back in…you do have some adjustments to do on the overall cost basis but you don't need to show 2 transactions, just 1, and you don't need to f-up your LT status. Not relevant to your Q.

      You can see that the above turned out to be a way too-long post, which makes me uncomfortable. Unfortunately, this response alone is probably just propagating bad habits (a tax Q came up in another thread). Not only should you not take the advice above as legal advice, it's a sign that tax stuff is complicated. Taxation discussion probably is inappropriate to have for the forum. B/c you really need to get more informed, need expert/reliable advice. There is way too much chance for most of us to talk out of our asses. Even if there are qualified subscribers (CPAs, tax attorneys, etc), I bet they would say: it's complicated, it can depend on tax jurisdictions incl country/state, the fact that you're asking means you need a lot more help than can/should be done in a forum, I'm not giving you off-the-cuff advice that might bite me in the ass, and my rate is $100-$300/hour if you want an informed opinion.

    • So let’s use andy’s Oliver character to illustrate Andy’s very important point.
      1) So imagine Unfortunate Oliver has 100K in Oct spreads and gets a double. 100K is taxable. The ST tax rate for 2013 is 39.5%. (LT is 20%). Then Oliver puts 200K into Jan12 spreads and by some freak of nature, Unfortunate Oliver is unable to attend to his spread as he gets hit by a car and is unconscious in the hospital. His Jan12 spreads expire worthless. Luckily, Oliver is now Fortunate Oliver in that Oliver gains consciousness and makes a full recovery on April 14, just in time for taxes. Oliver needs to come up with $39,500 for tomorrow– despite having no profits to speak of. Is Oliver Fortunate Oliver or Unfortunate Oliver, you decide

      2) Wash Sale rule
      My understanding currently is that yes, options are indeed subject to the wash rule, I have read about accountants who specialize in trading who believe options are subject.
      Further, if I understand this Wash rule correctly, the only time the wash rule comes into play whatsoever, is in the month of December.
      If you do not sell any position in the month of December, then you will never have to worry about the wash rule.
      If you do sell a position in December, then do not buy back any other similar position (same underlying) in the next 31 days.

      a) Since Andy’s thesis generally excludes purchasing any AAPL in Jan, since that is the time to sell not buy, you are generally OK.
      b) However, January is a good time to Sell to Open an upper leg against an unhedged leg. This needs further research but there seems very likely this sold upper leg is considered a wash sale and when bought to close, will be subject to wash sale rules.
      c) I am not an accountant, please do your own research. and if you do and find something i said above in error, please let me know.

      Here is a relevant link
      If you take losses in December don’t buy back the same stock for 31 days.
      If you take losses in any stock in December, be sure NOT to re-purchase the same stock (or an option on that stock) for a period of 31 days. If you do, your losses will be deferred to a later tax year. You won’t permanently lose the loss, it will just move forward and you will have a greater tax consequence in the current year…Many web resources advise you to stop trading a stock for 31 days any time a loss is incurred to avoid triggering a wash sale adjustment. However, as explained above this is quite unnecessary. The only critical time period is in the month of December where losses realized in December, or wash sale losses attached to open positions can turn around and bite you! </cite

      ALSO, for those that think they understand this, how do you take the meaning of this paragraph:

      Close out any open positions at year end that have accumulated wash sale losses. If you have any open positions at year end that have wash sale losses attached to them, these wash losses must be deferred to a later tax year. To avoid this unpleasant situation, close the open position that has a large wash sale loss attached to it and do not trade this stock again for 31 days.

      This seems to imply that losses on positions with wash sale losses attached to them (say a Jan13 400/500 spread purchased in Jan12 within 31 days of selling a similar underlying in December) cannot be taken in 2014 but rather 2015? That part I am very fuzzy on.

      • Looks like wash rules apply all year.. But the point is people often/sometimes want losses to show up on your taxes for the earliest year possible.

        Normally, a loss shows up in the tax return of the year you close the position for a loss. Say you sell aapl stock or spread for a loss during this Aug 2011 crash.. You would expect to put those losses on your 2011 return.

        However, if you buy back that exact same position in two weeks from now, it sounds like the wash sale rule treats the loss’s date as up in the air.. the position is still open and tax depends on when you close the new bought-back position. If you sell again in nov or dec 011 and get out of the market, it will still be a 2011 loss. If you hold into 2012, it will no longer be a 2011 loss.

        It sounds like your website is advising you to close such positions in december. Esp if you close at a loss in december, you might want to hold off on buying it back since witing a little bit can keep losses to this year.

        I find the website quotes a bit misleading since you do have to care about wash sales duing any month.. Not just december. A wash sale during any month might potemtially get carried over into tge next year. I guess they are trying to cover for this mistake with the last quote of yurs..

      • moomintroll has it. Dec has nothing to do w/ wash sales per se…it’s just that investors make trade decisions in Jan to take losses in order to offset gains. think of a wash sale being ignored from the IRS viewpoint…it’s as if you held the same position from the original purchase date. if you keep closed/reopened it many times in between and have “accumulated losses” — those losses can’t be taken in the current year unless you close the whole position and don’t retake it until >30d. Otherwise, it’s just another wash and you still have the original position from the IRS’s view point. This is really a splinter thread. I don’t think wash sales make much diff wrt the original post.

        • “make trade decisions in Dec” I meant to say. I’d suggest again that we not go down the rathole of amateur tax discussion. Apologize for adding fuel to the fire.

        • As for wash sales, I’m pretty sure you can’t do it with options, unless you’ve repurchased the exact same contract, same exp. same strike, everything. Each strike/exp is a different security, not considered equivalent for tax purposes.

          • i don’t think so – my understanding is that any option on the same underlying, regardless of expiration date or strike, is considered equivalent from a ‘wash sale’ perspective. i’m not an expert by any means. but some preliminary research i did last year seemed to yield that consensus. the main point i took away from it was that if you have a loss on an option trade, and you sell it but buy back another option position on the same underlying within 30 days, you “carry forward” your loss to the new position. so you don’t lose being able to “take a loss” on the position from a tax perspective, you just delay it. it can become a problem around year end like people have mentioned because if the new position is a loss when you close it out and you do it in the following calendar year, then you have pushed back the date (tax year) for when you can claim that loss. of course if the new position recovers and turns into a profit, then you don’t have the original loss. but i think the original loss is factored in to the cost basis of the position. so you’re not penalized for selling, but it could potentially delay when you can claim a loss on taxes. consult a tax expert as usual. i asked my tax guy these questions in the spring and he didn’t really know the answers without doing some research.

  14. Thx, Andy. Great idea, perfect timing, and succinct language. Although I do enjoy the style of Phil Davies …well, except his political ranting , your analysis and investment thesis sounds much more attractive to me. I understand your concerns regarding sophistication of the folks who have subscribed to BC. A simple boilerplate disclaimer on the subscription page will keep you in compliance with most of industry regulations. Please keep your work free from the PC BS.

  15. andy, excellent start, looking forward to the other chapters, esp valuation updates and risk assessment/mgmt. for the rest of us, just want to caution a bit against getting too excited…a 10x will take a lot of work and greed could clean your clock. don’t mean this in a patronizing way b/c I have enough scar tissue on my ass to last a lifetime. as others have pointed out and andy has confirmed, the central thesis will be based upon an aggressive rollover strategy, which andy already laid out a while back, and which is linked….meaning this strategy could already have been in play by any of us, so is not some new secret formula. of course, andy’s active analysis/guidance counts for a lot in making it happen…

  16. Andy, what do you think about legging into the October spread? We’ll likely see a big runup in late September with the iPhone 5 launch for rumored Oct 7 sale date, well in advance of October expiration.

  17. andy, i think it would be helpful and visual to include some charts of the vertical spreads you are suggesting to show how the spread cost changes over time vs apple stock. this would show how the spread reacts to draw downs in the stock.

  18. Andy,

    I just sent you an email but my account appears to have been suspended and my payment method is being declined. Shouldn’t be the case. Can you please have your team look into this?


  19. Andy,
    When do you think yor analysis of the Steve Jobs situation will be out?
    I would feel more comfortBle if I can get an idea of what to expect will have to AAPL before I purchase a spread that is <6 months.

    • This is somewhat important. Whenever i recommend apple to friends/co-workers as an investment, this is always the first and last objection – the company’s value is built on a charismatic leader who is terminally ill. This is wrong in at least one way, but if enough market players believe this, it becomes a self-fulfilling prophesy. I know a guy who is heavily invested in apple shares, follows the news carefully, and is fully aware of how much better apple is doing – on all fronts – than it’s competitors, but he will *not* hold it in his retirement account because he’s worried Steve Jobs’ demise will trash the stock.

  20. Question on iPhone heading into October. Seems like we usually see a sequential decline ahead of a model refresh. It is looking like we won’t get that refresh until next quarter so will that affect units? What are people’s thoughts? Do we see that again or has Asia demand changed that? I know Andy’s outlook models 23 M representing continued sequential growth. If we see that sequential decline, will the street react negatively? Or will iPhone 5 momentum trump that? interested in other people’s opinions.

  21. I see what you mean by the changing value of the spreads. The 355-375 is now just under your magic $10 level for the 2 bagger

  22. Test. Is anyone getting any new updates

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