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
$200,000 in April Call-Spreads (16.67%)
$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