The Apple Options Question: How to Take Profit and Reduce Risks?

Let's suppose that you were fortunate enough to have bought 5000 Apple (AAPL) common at 20 and were granted 10,000 Employee Stock Options 2 1/2 years ago with an exercise price of 37 which are now vested. You want to efficiently reduce risk and take profits without paying a large tax bill. Here's how to do it.

Apple's market price at the close on April 26, 2007 is 98.84.

Sell (write) 150 January 2009 calls with exercise price of 110. The sale could be made at 16.20. The proceeds of $243,000 would be credited to your account. If the Apple stock was fully paid for prior to the sale, most of the proceeds could be removed to do what you wish with the money. No taxes or interest payments would be accessed.

The equivalent stock position prior to the sale (write) of the 150 calls was long 14,700 (i.e. 5000 shares + 9700 from the ESOs). The equivalent stock position after the write would be reduced by 150 x .57 = 8550, making the new position + 6250.

There would have been no "time premium forfeited" back to the company. There is no current tax liability. There is no margin required to initiate this position. The deltas are still long 6250. The delta risk has been reduced 60%, erosion risk has been reduced by 100%.

If Apple goes down, stays the same or increases slightly, there will be a profit on the written calls over time. If the written calls are bought back at a profit or they expire worthless, a tax becomes due.

The profit would probably be a short term capital gain, which could be offset by any unused past or prospective liquidating of capital losses.

If the Apple stock rises substantially after the write, the written calls will cause a loss. But the gain on the stock and ESOs will be substantially more than the loss on the written Apple calls. The losses on the written calls will generate potential tax losses without having to liquidate gains on the stock or the ESOs.

Of course, if the employee has no Apple stock or assets other than the Apple Employee Stock Options, he may consider making some premature exercises and sales of the stock to reduce delta risk and to provide some required margin for hedging.

Efficient hedging by selling Apple listed long term out of the money calls will result in 40-50% more earning in the circumstances with Apple than the naive strategy of premature exercises of options, sales of stock and diversification.

If you think that Steve Jobs will be indicted or removed, it may be wise to consider buying a few slightly out of the money puts in lieu of writing as many calls.

Comments

[Tom B]

MSFT has back-dating problems; Apple's APPEAR to be under control with the indictment of Fred Anderson. I sure wouldn't be selling my AAPL.