Chapter 5: The Bullish Cross Apple Model Portfolio STRATEGY Part 1

Saturday, February 4, 2012 -- At the most fundamental level, the Bullish Cross approach to Apple Investing requires a pretty significant breadth of knowledge in vertical call-spreads. It is at heart, a short, intermediate and long-term vertical call-spread strategy. Vertical call-spreads offer a lot of major advantages not generally offered at the common stock level or even at the straight unhedged Call-Option level. Most retail investors with minimal working knowledge will go in and purchase Apple leaps. That is generally speaking, a pretty big mistake. If you're not aware of what a Vertical Call-Spread or Bull Call-Spread is, I highly suggest that you stop reading this chapter, and run a quick Google-search on Vertical Call-Spreads.

Assuming you have a pretty decent working knowledge of vertical call-spreads, the good news is that Bullish Cross has designed its Apple investment strategy in such a way that it doesn't matter when one becomes a member to the publication. The strategy is designed so that a prospective investor can jump into or out of the strategy at any time. That's because the strategy is a round-based investment thesis. You always enter the strategy at Round 1 and end at Round 4. Each round to the strategy begins right after Apple reports quarterly earnings, and ends just around a week before or after the next quarterly earnings report. Thus, each round lasts just about 13 to 14 weeks.

So for those who got into the strategy anytime ahead of July 2011 earnings, they're now technically in round 4 as of February 2012. July was Round 1, October earnings was Round 2, January earnings ended Round 3 and April earnings would constitute the end of Round 4.

The strategy fully matures, completes and ends after Round 4. At that point, the portfolio undergoes something called a rebalancing ahead of another Four-Round series. Thus, the strategy is based on a 1-year execution period that starts when you enter the strategy and ends just about a year later.

For that reason, we will discuss why it is always probably best to rebalance and re-start the strategy with Apple's January earnings regardless of when you began. So for example, if you happen to be at Round 2 once January earnings have completed, we're going to demonstrate why it is far superior to end and rebalance the strategy then.

Therefore, it really doesn't matter when you become a member to the publication or when you decide you would like to be part of the strategy, you will always start in Round 1 and end at Round 4. You can choose to end the strategy prematurely in order to rebalance and start fresh in January. I know at this point, none of this makes any sense but I promise you it will. It's a pretty profitable and ingenious strategy. The reason we want to point this out from the get go is because we don't want people to feel left behind, so to speak. You can come in today, and you will start at Round 1 while many others may be at Round 2 or Round 3.

Think of this as a competitive sport with four quarters like Basketball or Football. Each quarter of the Bullish Cross Apple Investment Strategy spans a 13 to 14 week period. You can enter the strategy at anytime during the quarter -- week 1, week 5, week 7 or even week 13. Just as long as you're in ahead of Apple's earnings, then you will be considered as being a part of the round. You can even decide to start in January, complete Round 1 to the strategy in April, leave for the quarter, and then decide to come back for the October quarter. The best way to think of this investment thesis is that once you complete a total of four rounds -- consecutive or staggered -- the strategy is complete and you need to rebalance your portfolio for the next "game" or the next "four-round" period.

Bullish Cross has decided to completely very recently rebalance the Bullish Cross Apple Model Portfolio after Apple's Fiscal Q1 2012 earnings in January, so that we've started at Round 1 in this January - April period. The reason we think it's a far superior strategy to rebalance and begin anew in the end of January or the beginning of February is due to the fact that the core position is held in Leaps.

So in January 2013, our core Apple position will expire and we will need to take a new core position. We will get into this in more detail. But just remember that this strategy revolves around the core position which always expires in the month of January. Thus, the way I imagine this strategy is that we liquidate everything in January and then start over sometime in February. The strategy ends in the following January/February time-frame, and we start over again.

The Basic Thesis: The 33.33 - 50 - 16.67 Strategy
Let's start with the very basics and then add some layers of complexity as we go along. Remember, this is a round-based investment strategy that is focused on short, intermediate and long-term vertical call-spreads in Apple. Keep that in focus as you work through this material.

Suppose you have delegated $1.2 million to invest in Apple. The first thing you do when planning for this strategy is divide that number by 2. That will give two allocations of $600,000.00. What you do with the first $600,000 is buy a core long-term position in Apple that expires in January. Depending how conservative you want to be, you can buy anything from a deep in the money call-spread or a slightly out of the money call-spread.

For example, if you look at the Bullish Cross Apple Model Portfolio is holding the January 2013 $400 -$500 Apple call-spread which is valued at $52.95 a contract and it makes up just about 52.28% of the entire portfolio. Now while that position is up well over 200% already from when we originally purchased it in June, that doesn't matter from a balancing point of view.

When we rebalanced the portfolio this past January 2012, we intentionally reduced the size of the weighting down to 52.28%. The position now makes up roughly half the portfolio. So in the illustration above, here is how we would start with the Bullish Cross Strategy. We would use $600,000 to buy something like the January 2013 $400 - $500 call-spread at right around $50.00 a contract. That would give us a 120 contract position in that vertical call-spread.

Thus, at this point the weighting is 50% cash and 50% January 2013 $400 - $500 Apple call-spreads. If Apple closes at or above $500 a share in January 2013, the value of that call-spread will be worth $1.2 million. Thus, as long as Apple closes above $500 a share in January, it is impossible for us to lose money given the fact that the entire portfolio started off at $1.2 million and half of our account would be valued at $1.2 million as long as Apple > $500 in January 2013.

So that brings us to the question of what to do with the other $600,000 allocation that is sitting in cash. This is where things get relatively complicated and where it will require paying very close attention in order to avoid getting lost or confused.

What we do with the remaining $600,000 allocated to Apple is we divided that number by three. That gives us three $200,000 parts to be allocated in different ways. One allocation is cash. So that is easy and straight forward enough. The other two parts will be allocated to short and intermediate term strategies that we will discuss at length below. That means exactly 16.67% of the entire portfolio will be allocated exclusively in cash for at least ROUND 1 of the strategy.

The Short-Term Strategy: 16.67% Allocation
So as we explained above. $600,000 of the $1.2 million we have set aside for Apple would be allocated to a January 2013 $400 - $500 call-spread @ $50.00. The other half of the money will be allocated equally in three parts: $200,000 in Cash, $200,000 in short-term strategies, and $200,000 in intermediate-term strategies. We're going to discuss the short-term strategy here.

This is the part of the overall Bullish Cross Apple Model Portfolio strategy that we spend nearly 80% of our time on. If you get this part right, then you will have executed an incredibly lucrative strategy. The part that has the highest level of uncertainty and which requires a significant amount of talent, skill and ingenuity to execute, is the short-term strategy.

What we do with the $200,000 we have allocated for the short-term position is this. We look for either a $10 or $20 short-term spread that expires in the month Apple reports its next quarterly earnings -- April in this case. What we mean by a $10 or $20 spread is a spread that is $10 or $20 wide. For example, the $380 - $400 Apple call-spread is a $20-wide spread. A $390 -$400 call-spread is a $10 wide spread. What we usually look for is a $20 spread first, and then we entertain a $10 spread usually at the bottom of corrections.

So what we do is find the most conservative $10 or $20 spread that would yield a 100% gain on expiration. For example, in October we ended up purchasing the Apple $370 - $380 Call-Spread at $5.00 a contract. That means as long as Apple closed above $380 at expiration, the spread would be worth $10.00 yielding a 100% gain. This is integral to the entire Bullish Cross Apple Investment Strategy. The spread we purchase must yield at least a 100% return at expiration.

So for example, Apple's next earnings report is in April 2012. Thus, we consider the "short-term" strategy as the April options-expiration. Apple will very likely report earnings pretty much a few days after April options expiration as pointed out by Bullish Cross Contributor Paul Whitlock.

Thus, if we were to buy the April spread today, the most conservative spread is the Apple $460 - $470 Call-Spread @ $5.00 a contract. As long as Apple closes above $470 come April expiration, we would gain a 100% return on our $200,000 short-term investment. Yet, given that Apple has made such a monumental run since November, we are waiting on the sidelines for a big pull-back which may allow us to buy a much more conservative spread later in the quarter. For example, if we are able to buy the $440 - $450 spread at $5.00 a contract, we would be far better off.

The whole point of the short-term strategy is to produce a 100% return on our short-term position. We have 13-14 weeks in the quarter to determine the best time to enter our short-term position. So far, we've succeeded in producing a 100% return for most of our members both in the October and January expirations. The strategy began in August after Apple's July earnings.

In summary, the takeaway here is this. At ROUND 1, you want to be allocated 50% in a core long-term Apple positions, 16.67% in cash, 16.67% in a short position and 16.67% in an intermediate-term position. For the short-term position, the goal is to purchase a call-spread that expires a few trading sessions from when Apple reports its earnings. Apple reports earnings during the third or fourth week of January, April, July and October. The ENTIRE Bullish Cross Apple Model Portfolio Strategy is focused exclusively on those options expirations.

So given the fact that we current in the month of February 2012, our short-term portion of the portfolio will be focused on purchasing an Apple $10 or $20 wide Vertical Call-Spread for the April expiration. The goal is to make a 100% gain on that spread. That means if we decide to buy a $10 call-spread, we can't pay more than $5.00 for the spread. If we buy a $20 call-spread, then we can't pay more than $10.00 for that spread.

Thus, it stands to reason that once we decide that Apple has bottomed for the quarter, we want to be focused on purchasing the most conservative call-spread that costs us just under $5.00 for a $10.00 spread or just under $10.00 for a $20.00 spread. In the last week of November 2011 for example, as we called a firm bottom in the Apple post-earnings correction, we saw the January $370 - $380 call-spread trade at around $4.50 a contract. We advised our subscribers to buy that spread at that price. Why? Because it was the most conservative spread at the time we decided that Apple bottomed.

As most of you are aware, that spread had reached full value way ahead of expiration given that Apple rallied nearly $40 above the upper strike of the $370 - $380 call-spread. As we got closer to expiration deep in the money, that spread resulted in a 100% to 120% gain depending on when the average BC Subscriber purchased that spread. A lot of members at Bullish Cross made out in a huge way on that spread including myself.

Finally, before we move on to the intermediate portion of the strategy, it is crucial to remember that when it comes to the short-term part of the Bullish Cross Strategy you need to be aware of the following or this doesn't work:

(1) Make sure you buy a spread that will yield at least a 100% return at expiration.
(2) Pick the most conservative $20-wide spread at no more than $10.00 a contract; OR
(3) Pick the most conservative $10-wide spread at no more than $5.00 a contract.
(4) ROUND 1 Allocation: 50% Core; 16.67% Cash; 16.67% Short-Term; 16.67% Intermediate-Term
(5) Wait for Bullish Cross to call a firm bottom in Apple during the quarter before jumping into the short-term position

The Cash "Bail Out" Strategy
It is important to understand that when it comes to the short-term positions, intermediate-term positions and cash positions, we will always have an equal weighting. Once each round is over, there is a reallocation that takes place which results in a perfect equal proportion in the short, intermediate and cash positions.

For example, once ROUND 1 is over in April, we will make $200K in gains on the short-term strategies. That will give us roughly $800,000 between the short, intermediate and cash positions. What we do in April is reallocate that $800,000 equally to those three core positions. So in ROUND 2, we would have $266K for short-term positions, $266K for cash, and $266K for intermediate term positions.

Now here is precisely why we do that. We do that because it is important to have an equal amount of cash and short-term positions. Now the reason it is important to have an equal dollar amount in short-term positions and in cash is because of what we call the "Bail Out" strategy.

Suppose we purchase the April $460 - $470 Call-Spread @ $5.00 contract with $200,000.00. That would give us 400 contracts @ $5.00. Now suppose after we purchase that spreads as part of the Bullish Cross Apple Model Portfolio Investment Strategy, Apple undergoes a $40.00 correction down to $420 a share. That spreads would probably lose 80% of its value in that set of circumstances.

Yet, because we have $200,000 sitting in cash on the sidelines, it allows us to effectively dollar-cost average by purchasing a very conservative spread that we have a very high level of confidence would result in a double. For example, if Apple sold off down to $420 a share, we may be able to buy the April $410 - $430 spread @ $10.00 a contract.

Now suppose after we do this, Apple goes on a massive second-half of the quarter rally that brings the stock back up to $450 a share several weeks before Apple reports its earnings. That would result in two huge positives. First, it will likely result in the $460 - $470 spread getting back to even-Steven. If that's the case, we would sell the $460 - $470 spread returning our full 16.67% cash level back to the sidelines.

Yet, look at how we ended up. We are now far better off. Instead of holding the $460 - $470 spread @ $5.00, we're now holding the $410 - $430 spread @ $10.00. We've now increased our chances of ending the quarter with a successful 100% gain in the short-term strategy which is integral to the entire strategy. What if we decide that the $460 - $470 isn't in any danger and we think that Apple will probably go right through $470 by expiration? We may decide to continue holding our $460 - $470 spread and now we may end the quarter with not only one, but two successful 100% short-term position gainers. We're now way ahead of the game, so to speak.

So that is precisely why we have an equal weight of cash and short-term positions. We need that cash to always be there to potentially bail out our short-term positions. In a sense, the initial short-term position that we take acts as an upside hedge against the possibility of Apple running into the sky. If Apple sells off, our cash is a downside hedge. If Apple goes up, our short-term position that we already have is an upside hedge. It's a beautifully contemplated balance of mathematical precision. That brings us to the intermediate portion of the strategy.

The Intermediate Term Strategy: 16.67% Allocation
To review. Here's what the Bullish Cross Strategy entails. If you have $1.2 million allocated to buy Apple, you take that $1.2 million and you divide that number by 2. That gives two $600,000 parts. You take the first $600,000 part and allocate it to a long-term core position that you will never touch until we get to January expiration. That could mean buying any number of January 2013 call-spreads. I think the $450 - $500 spread is still the best all-around spread to buy.

Then you take the $600,000 left over and you divide that number three. So that gives you three $200,000 equal-parts. One part is allocated to cash. One part is allocated to a short-term strategy described above and the final part is allocated to intermediate-term strategies.

Now for the intermediate-term strategy, you're going to take that $200,000 and divide by 2. That will give you two $100,000 parts. What you do with each is quite simple really. Eventually, we're going to get to ROUND 2 and ROUND 3. As Apple goes higher, spreads that may seem reasonable today or that might even seem very cheap today become more and more expensive.

So what we do to get ahead of that is allocate a certain amount of our capital to spreads expiring in the next two quarters after this one. So for example, given the fact that we are trading in Apple's fiscal Q2 2012 which will end in April, that means the next two reports will happen in the July and October options-expiration.

At the end of ROUND 1, we will take the money we made on April along with the original investment and re-allocate that to July, October and January 2013 expirations. It's very important to understand that at the end of every round, the short-term allocation, intermediate-term allocation and the cash-allocation will always be in equal weight. This quarter it was $200K cash, $200K short-term and $200K intermediate-term as per the illustration we began above. If Round 1 ends successfully, then in Round 2 we will have an additional $200,000 in cash to allocate to all three positions. Thus, in reality, we would have $800,000 to be allocated across three strategies -- $266k in cash, $266K in short-term and $266K in intermediate-term strategies.

The reason we're pointing this out now is so you can get an idea of what the intermediate-term strategy is doing for us. Once April is behind us, then July becomes the short-term strategy and position. Once July is over, then October becomes the short-term strategy and position.

By taking positions for those expirations now rather than later, it is giving us the possibility of being able to get our full position at a reduced cost down the line. It also serves as a good upside hedge. Suppose Apple just skyrockets one quarter. The later intermediate-term spreads will give us some protection by preserving our ability to be able to buy reasonable spreads at a reasonable cost-basis down the line.

For example, suppose we are able to buy the July $480 - $500 call-spread at $3.50 in November. If that spread goes up to $12.00 in May, we would be priced out given the "don't buy a $20-wide spread for more than $10.00 rule." Yet, because we bought a good chunk of the ultimate full-sized position at $3.50, we will have the ability to reduce our cost-basis way below $10.00 in the future. So that is the purpose of the intermediate-term strategy.

In terms of the allocation, as we said above, we would buy $100K worth of a $20.00 July spread and $100K worth of a $20.00 October spread. Now for those of you who are new here, it is important to understand that we publish a live commentary during every single trading session in our Bullish Cross Live blog.

How to Use Bullish Cross as Guidance on Executing this Strategy
This chapter on the Bullish Cross Apple Investment Strategy is assumed knowledge. We assume that everyone who is following the Bullish Cross Live Blog fully understands the ins and outs of this entire strategy by heart. Most of our subscribers are following this strategy, and understand it pretty damn well.

During the day, we elaborate and expand on this analysis in our live blog. In fact, there is probably on the order of 10 to 20 times more material in the BC Live Archive covering this strategy than there is here. The true value of Bullish Cross lies in taking and mastering the material presented in each part of the site, and then showing up every day to read the BC Live commentary and comment section. The comment section is a very rich source of information. Think of this chapter as the textbook and BC Live as the classroom environment. You need both to succeed and to execute this strategy well.

Moreover, we actually execute this entire strategy live throughout the year by making the trades pertaining to this strategy live in the BC Live Blog. We send out our trades up to the minute through Twitter notifications which you can have set up to be sent to your mobile phones. The vast majority of our 500+ membership-base has signed up for twitter and most have mobile alerts set-up on their accounts.

You can visit the Bullish Cross Apple Model Portfolio which is the precise model portfolio for how to execute this strategy. We make the trades in the BC Live Blog, and then we later transcribe the trades in the Bullish Cross Model Portfolio page. We tell you when we think Apple has bottomed, which spreads to buy and why and we walk everyone through the entire quarter. We hold your hand through the entire process. It's up to you to understand this material and then show up every day for class, as it were.

So the best way to follow Bullish Cross is like this. Read the Apple earnings material, the valuation material, the material on trending and finally the material on investing. Once you have all of that down cold, you should then start to closely follow what we're doing in Bullish Cross Live. Because in reality, all we are doing in BC Live is laying out where we think the market is headed and why, where Apple is headed and why and we're executing, elaborating and expanding on those four major themes: Earnings, Valuation, Trending, Investment Strategy.

In the next section, we're going to spend a lot of time covering how things will look like from beginning to end by detailing how to re-allocate at the end of each round. We will also lay out how the entire strategy as a whole works together. This is just a broad overview of how we would allocate our Apple position at the start of the strategy. As things evolve things become very complicated.

Here is what ROUND 1 allocation would like if you had set aside $1.2 million to invest in Apple. Note, this allocate is exactly the same regardless of the dollar amount. You just rescale by applying the percentages. Remember, you start off by taking the capital, and dividing by 2. One part goes to the core position. The other part is split in three. One part goes to short-term strategies, one-part goes to intermediate-term strategies and the last part is allocated to cash. The intermediate-term strategy is divided by two. Each part goes to purchasing an intermediate-term spread. That's basically it.

ROUND 1: January - April
Short-Term Strategy
$200,000 in April Call-Spreads (16.67%)

Intermediate-Term Strategy
$100,000 in July Call-Spreads (8.33%)
$100,000 in October Call-Spreads (8.33%)

Long-Term Core Strategy
$600,000 in January 2013 Call-Spreads (50.0%)

$200,000 in Cash

35 responses to “Chapter 5: The Bullish Cross Apple Model Portfolio STRATEGY Part 1

  1. Thank you for this Andy, as a new member I’m particularly grateful for your structuring the strategy to allow for new arrivals (in addition to it being a good method for re-balancing for existing members), I’ve been studying a whole lot since I got here about a week ago and I’m very impressed with your work, the clarity of your explanations, as well as the knowledge base of the community. Now just waiting for your nod to implement.

  2. Andy, I like the simplicity of this method a lot. I also like that the short term trades get rolled into the next short/intermediate term trades rather than adding to the core – nice leverage there. I’m sure you’ll discuss this more in the future articles, but the drawback with this strategy seems to be that the core position would not get long term tax treatment if you don’t take the core position until after Jan expiration and you’re buying the following year LEAPS. (I’m hoping to get to Romney’s 15% tax rate :) ). This does sound like a great strategy for retirement accounts though. Also, having only 1/6 of the portfolio in cash sounds pretty aggressive to me – I’m leaning to 25% for my personal portfolio but I guess I’m a bit more conservative.

    By the way, you work some crazy hours! Thanks for all your hard work.

    • The question about how to get long term gains is a good one. Since BC was recommending the Jan ’13 400-500 spread last June, which was 18 months out and did qualify for LT treatment, there isn’t any reason that it couldn’t be done for 2014.

      This is just the first article so there will be more to come, but the short term and intermediate positions intersect with the core position 3 out of 4 quarters. By that I mean simply applying the above strategy will end up piling intermediate or short term allocations on top of the pre-existing core position. With the core already riding on January ’13 it seems risky to include the LEAP quarter in the ongoing quarterly action. Both positions will grow, but the Core will grow slower than the other stuff. By October, when Jan ’13 would be technically be due 16.67% (which has grown substantially) to the 50% we put now on January ’13, there would be too much riding on January ’13. So if starting in the April (round 2) we allocate 8.33% to January 14 instead of January 13 it would spread the risk and, bringing us back to your question, provide LT treatment for at least some of the Core for Jan ’14.

      Anyway, this looks like a really great strategy. I’m looking forward to following the BC program as it rolls out.


      • One other thought on getting LT gains is to roll out of the Jan ’13 a few days early and roll right into Jan ’14. It’s not like it will work every year, but if you bought the Jan ’13 early, say back in June of ’11, then it would get LT and you could get LT for both ’13 and ’14. Eventually there will be a year where you have to bite the bullet and take ST, but it might work out. This assumes that by Jan ’13 those spreads will be DITM so that in the last weeks those spreads will be at 99% of value.

        • Of course the Jan ’14’s might not be well priced at that time which would be towards the end of the Q1 earnings run. But it would provide LT tax treatment. That just might not be the most important thing to consider.

  3. Since it isn’t emphasized, I feel it necessary to point out that these percentages are of the total amount you wish to dedicate to Apple-related strategies, not percentages of all of your investable assets. I think the previous comment on cash percentage might be missing this nuance to the whole discussion.

  4. Andy,

    Thanks for taking the time to write this article. Even though we’ve seen most or all of it before, it’s helpful to have it spelled out so clearly.

    Three questions:

    (1) I’m confused about the amount of money you recommend keeping in cash. Is it 25% (as in 25-50-25) or 16.7% (equal to the short term position)? If the latter, should this model be called the 16.7-50-33.3?

    (2) What is the reasoning behind the strict rule that the short term spread be a 100% gain? I.e., a $20 spread for <=$10 or a $10 spread for <=$5. Might there not be circumstances in which, based on our view of where the stock price is headed, that the risk-reward calculus favors making a somewhat safer bet that brings in “only” 80% or a somewhat risker bet that brings in more than $100? Or should we always go for the 100% return and count on our cash reserve to help us out if it looks like it won’t hit?

    (3) We purchased the July 480-500 spread at $4.50. Is it a general rule that for the farther out intermediate spread we’ll look for a 4-1 payout, or was that just a one time deal based on where the stock was and the expect gain related to the January earnings?

    Thanks very much!

    • +1 on your (1) question. I don’t see were the 25%-50%-25% is.

    • Hi there. I’ll try to help on these…

      1. The strategy changed to put more cash to work in the short and intermediate-term. The original 25 / 50 / 25 allocation was based on leaving cash on the table even after a short-term bailout in case of an all-out crash. While BC hasn’t shared the reasoning for this, my personal thinking is that this was done because a) the valuation is already so low that the possibility of an all-out crash is quite low at this point and b) any crash should be short-lived and the long-term spreads should bail you out anyway.

      2. In general, rules give you the ability to make good choices in the heat of the moment without getting paralyzed by all the data. But you answered your own question quite well. Buy a double when it looks like were bottoming, then use cash if we go lower.

      3. The July spread was taken as an upside hedge. The overall goal is still to get a conservative double in July. Taking positions early just makes it easier. BC actually covered this one a bit: For example, suppose we are able to buy the July $480 – $500 call-spread at $3.50 in November. If that spread goes up to $12.00 in May, we would be priced out given the “don’t buy a $20-wide spread for more than $10.00 rule.” Yet, because we bought a good chunk of the ultimate full-sized position at $3.50, we will have the ability to reduce our cost-basis way below $10.00 in the future. So that is the purpose of the intermediate-term strategy.

      • Thanks aparkinson.

        (1) Understood, just confused then why we still call it the 25-50-25.

        (2) I guess that’s a valid reason, but I’d think we could have some flexibility without getting paralyzed by the data. For example, right now the April spread returning 100% is the 455-475. If AAPL dips down to the 420-430 range, we should be able to get into a lower spread for $10, but if AAPL just consolidates at this level for the next few weeks, maybe the $10 spread is at a level that doesn’t seem all that safe (say, e.g., the 450-470). Under those circumstances, maybe it would be preferable to buy a more conservative spread that returns something less than 100%. Seasonality could be a factor in this analysis.

        (3) Understood, my question is whether as a general matter, we should be looking for higher spreads that pay 4-1 for the further out intermediate spread. So, for October, should we be looking at 440-460, which Andy has mentioned, or something higher up the chain?

        • hah. Totally missed the reference to the 25-50-25 in the heading. Good point. :)

          I think for (3) july was a special case that paid homage to where Andy thought we’d be in terms of EPS and the history of July bullishness after many months of consolidation in the first 1/2 of the year. Then we get bearish for a bit after that and October is generally a bad month for the markets, so it makes sense for October to be a safer bet. This is just how I interpret things, though.

          • My understanding regarding (2) and (3) is that all this rebalancing is happening so that we can just follow the Portfolio and Andy’s recommended spreads and trades.

            The exact spread that Andy/BC recommends will be considered taking everything into consideration at that time. It’d be difficult and some of things are impossible to cover all that in an article. I believe there is no hard and fast rule but these are general guidelines. For example, there is not a big difference between 100 and 80%. It’s also a matter of how much risk one can take individually because the short-term trade is not always going to a 370-380 spread when the stock is sitting at 420 as it happened last quarter. The general guideline on this whole strategy is that we will try to make 100% profit (or as close as to it) on the short term trade. The exact spread will be recommended by BC from time to time.

            The strategy is oriented such that at any given point of time any individual can get into intermediate and long-term (of course not straightaway on that day as we are waiting for a pull-back now) and short-term at some suitable point before the earnings.

  5. Is there any reason why Andy only recommends the $10 or $20 spreads. I have been having good luck with the $5 spreads also. Just wondering if there is more risk with those? Thanks

    • I don’t think it’s a risk issue, I think it’s an efficiency issue.

      Assume that you’ll often have to trade out of a spread before it reaches full value. Let’s say that transaction costs you $0.25 per contract.

      On a $5 spread, you give up 5% of the spread value for that transaction.
      On a $10 spread, that transaction costs 2.5%.
      On a $20 spread, you’re only losing 1.25% to transaction costs.

      So buying larger spreads is more efficient in terms of transaction costs, but it also means greater risk simply because it’s a wider price range (i.e. there is a larger chance that AAPL closes somewhere inside the spread). So on balance, the $10 and $20 spreads are the sweet spot.

      • I think you are making a mistake with those numbers there.. $0.25 per contract means 25 cents on a contract with 100 shares of AAPL. So you pay 25 cents on $500 worth of spreads (if in the money.) You seem to assume that it is 25 cents on $5 worth of spreads!

        • But if you’re buying $5 spreads, can’t you buy a lot more contracts with (say) $200k than if you’re buying $20 spreads? And if that’s true, wouldn’t you have higher trading costs than if you purchased a smaller number of higher-priced spreads?

    • The narrow spreads are potentially a lot more volatile than the wider spreads. For example, if you have a $5 spread with Apple stock just a few dollars over your upper strike, a slight change in Apple value makes a huge difference in the value of the spread – for better or worse. Also, you do need to consider that the risk for a total loss is much higher with the narrower spread – another reason to be careful with putting too much of your portfolio on a narrow spread. As Cliftonk says, the risk for a wider spread is that there is a higher chance that the stock ends up between the strike prices.

      Just from my observations over the last few months, it seems like the $5 spreads are perfect for playing an event like earnings with a small amount of your portfolio but may be too volatile to have a significant amount of money riding on them for a bigger position.

      Of course, the transaction costs will be more as well.

      I don’t think it’s any magic about the width of the spreads you choose. The practical reason to stick to one set of spread width is that it’s easier to “cross shop”, compare, and follow the value of different spreads – at least it is for me.

  6. Andy, I thought the initial June 2011 $400-$500 vertical call spread was brilliant. But watching you learn and evolve the strategy to this form in a mere 7 months, is pure genius! I feel so fortunate to be a member of BC! Completely agree with Murali that you work crazy hours too – your passion shines right through.

    A couple questions on rebalancing:
    1) if we do double after a round, should we consider rebalancing the core position too? e.g. after the quarter $600k becomes $800k, should $100k go into the core position while remaining $700k gets divided into cash, short and intermediate terms? (the $100k could go into 2014 LEAPs to support Murali and Pew’s points about long-term tax treatment, and not overweighting next Jan spreads)

    2) Thoughts on how to rebalance if strategy fails for a quarter? Do we trim back to 50% core + (1/6 cash, 1/6 short, 1/6 intermediate)?

    • As I understand it, rebalancing happens once a year (in January)

      • aparkinson – this is a little off topic, but for the life of me i couldn’t find something you had posted as a hedge to the july appl spread with a put spread in the live blog within the last 3 days…
        i thought the logic behind it was solid and i myself wanted to follow it but never got around to it. Would appreciate you sending a link to it. thanks.
        i can be reached at

  7. Andy, you have also mentioned about having 20% always sitting in cash and it’s only used during a capitulation which goes back to cash after the bounce, once the consolidation start. Is my understanding correct on that? Would that make sense to be incorporated in the strategy? In addition to having the 16% cash in sideline to bail out the short-term spread, do we need additional cash on the sideline to catch the capitulations?

  8. @Pew: I know it sounds like it could be pretty risky having a large core position expiring in Jan and then adding on short and intermediate term positions on there also, but I’m thinking that the wide spread of the core position makes it pretty safe. The core position with a spread of $100 should move very little the last few weeks since the lower strike is so much lower – there shouldn’t be any sweating if Apple makes a $5 or $10 move down a few days before expiration – it won’t wipe us out. I can imagine having my core Jan13 400-500 position along with something like the 520-540 (or something like that) for the short/intermediate term. Barring a black swan type event (fingers crossed), I think it’s still safe to have both types of positions. I’m curious to hear others’ opinions on this.

  9. Okay, so I know this article is only “part 1”, but I put together a simple spreadsheet for the strategy using my interpretation of what to do with the gains from each expiration. Here’s a screenshot:

    I used Andy’s hypothetical 1.2m starting capital. I added arrows to show how I thought the gains would be distributed in order to maintain proper allocations (ie. cash grows proportionately with the ST allocation). Does this seem like an accurate interpretation of the strategy?

    • Stockmusician, one significant difference between your spreadsheet (if I’m reading it correctly) and Andy’s description in this article is that after each quarter, he redistributes so that ST, intermediate term, and cash are all equal. So after a successful April trade, you should have $266k in cash, $266k in ST, and $266k in intermediate spreads. It looks like you don’t have as much going to intermediate term, but your cash and ST are equal.

      I do like your assumption of the core $600k being worth $1.8 million at expiration – I think that’s a pretty good level of risk and one that I think the Jan13 450-500 could get us to if we time it correctly.

  10. Andy, two things stand out about this article:
    1) Your passion, dedication, and hard work.
    2) Just how efficient an investment the 50% core portion is.
    Assuming we will probably be able to purchase the Jan 13 450-500 for 2.5x by Jan 13.
    In contrast, assuming we consistently succeed in doubling our short-term portion ( a third of the other 50%) we will make 1/3 or 33.3% each quarter, leading to approximately 3.2x by Jan 13 for the non-core half. Not a striking difference considering the exponentially greater effort and possibly greater risk.
    Of course, you may well be planning to get doubles on the cash portion in some quarters, which then drastically changes the results. If we were to consistently achieve doubles on the cash each quarter, in addition to doubling the short-term position, we would make 2/3 or 66.6% each quarter, resulting in approximately 7.7x by Jan 13.
    I guess the results for the non-core 50% will thus be somewhere between 3.2x and 7.7x………quite impressive!
    ( I realize there are other variables….these are just some back of the envelope calculations…)

  11. great article. thanks andy.

  12. If I were to start a core position now with a Jan 13 450-550 BCS , Apple needs to be where it is now for me to break even by expiration. The position can be established for a debit of~ 4500-47 00 per contract. The question is, would I be better off waiting till consolidation is over? My concern is that overall market Vol will increase and so will apple’s, it is trading at a low IV now. Given this probable outcome, and further assuming, the IV differential to remain constant, I think I should wait; but it is very likely that the difference in IV will widen, resulting in a more expensive price for the 450 strike . I apologize, if it appears that I am answering the question I posed at the start; I am putting this out to see if my thought process is valid.

    To simplify: Should I start a core position at this time or wait till consolidation is over?


  13. Sorry for the late reply.

    Wait was the answer on BC live.

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