Lately, investors in Apple (NASDAQ:AAPL) have faced a dilemma. With the stock down as much as 30% from its highs last year, value investors look at highly attractive multiples on Apple as reason to buy. Yet given how many momentum investors the stock attracted on the way up, it's reasonable to fear the impact that they have had on the way down.
If you've been looking for a way to manage your risk with Apple, you've faced a big challenge. But now, a recent innovation from the options market could give you the answer to that challenge. Let's take a closer look.
Announcing new mini-options
Many investors see options as being risky in all circumstances. Used properly, though, options can actually reduce risk by allowing you to define exactly how much exposure you want to a stock's price movements.
But with Apple and a host of other companies, the structure of traditional options contracts has been a barrier to using options for risk management. Historically, options contracts covered 100 shares of the underlying stock. For many stocks, that number of shares corresponds to stock with a value measured in the hundreds or thousands of dollars. Yet with Apple, 100 shares of stock is currently worth $45,000 -- a much larger position than most investors want to take.
In response to the demand for options on companies with high share prices, options exchanges have released so-called "mini-options" on five different securities. Along with Apple, fellow tech stocks Amazon.com (NASDAQ:AMZN) and Google (NASDAQ:GOOGL) will have options contracts available that cover just 10 shares of stock rather than the usual 100. In addition to those individual stocks, two ETFs will also have mini-options available: SPDR Gold Trust (NYSEMKT:GLD) and SPDR S&P 500 (NYSEMKT:SPY).
How can mini-options help you?
The solution that mini-options provide is that they allow you to match up your stock exposure in executing popular options strategies. For instance, neither Google nor Amazon pay a dividend, making the stocks less attractive for income investors. But by using what's known as a covered-call strategy, you can write a call option that commits you to sell your shares to the option-buyer at a specified price for a certain time into the future. In exchange for making that commitment, you receive an upfront payment called the option premium.
Before mini-options were available, though, investors who owned less than 100 shares of stock wouldn't have been able to execute a perfect covered-call strategy. If they had written a single call option, it would have covered more than their ownership stake in the company, leaving them vulnerable to having to buy additional shares of stock if the option-buyer exercised the call option. By contrast, with mini-options available in 10-share increments, it's easier to write mini-options to give you the right level of exposure for the shares you actually own.
On the other hand, investors who want exposure to a stock's upside while limiting downside risk can buy call options. For instance, a call option to buy Apple stock for $450 any time between now and mid-April would cost you $16.50 per share as of yesterday's close. If the stock rises to $500, then your option would rise in value to $50 per share, letting you triple your money. Meanwhile, if the stock falls to $400, you'll lose every penny of the $16.50 you paid for the option -- but that's still far less than the $56 per share you would have lost had you bought the stock outright at yesterday's closing price of $456.
Should retail investors buy options?
Most of the bad reputation that options get has to do with the fact that you can use them as ways to greatly increase the amount of leverage in your portfolio. Often, you can end up losing your entire investment when you buy an option. But if you use lower-risk strategies, then mini-options could help you do things you wouldn't have been able to accomplish without them.
Fool contributor Dan Caplinger owns shares of Apple. You can follow him on Twitter @DanCaplinger. The Motley Fool recommends Amazon.com, Apple, and Google. The Motley Fool owns shares of Amazon.com, Apple, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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