Comparison of Apple ESO  Strategies
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Comparison of Apple ESO Strategies

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Illustrates the advantages of selling calls versus the strategy of early exercise, sell and "diversify" ...

Illustrates the advantages of selling calls versus the strategy of early exercise, sell and "diversify"

John Olagues
www.truthinoptions.net
olagues@gmail.com
504-875-4825
http://www.wiley.com/WileyCDA/WileyTitle/productCd-0470471921.html

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Comparison of Apple ESO  Strategies  Comparison of Apple ESO Strategies Presentation Transcript

  • .Comparison of Selling Callsagainst Apple ESOs with the strategy ofPremature Exercise, Selland Diversify
  • .Comparison of Selling Calls with Early Exercise and DiversifyAssumtions:1. You own 1000 Apple Computer Employee Stocks Options to buy stock at$300 that have just vested after two years.2. Apple is trading for $561 on June 1, 20123. The calls that expire in Jan 2014 have 19 months to expiration.4.The January 2014 calls with an exercise price of $600 are trading for $9380each.5. You have $60,000 of loss capital carry fowards from previous other stockpositions that were liquidated.5. You have a choice of selling 6 calls or making early exercises and sell thestock and diversify into the S & P 500 trading at 1278 on June 1, 2012.6. You are a resident of California.
  • .If you exercise the 1000 ESOs and sell the stock at $561 you will net after taxapproximately the following amount after forfeiting 100% of the "time value".$561,000 - $300,000 x 55% = $143,550.You would have terminated your alignment with the company 100%. Effectivelyyou have made a bet against Apple and in favor of a bet on the broad market.--------------------------------------------------------------------------------------------------------If you sell 6 calls you will still own the 1000 apple ESOs and receive $56,280from the call sales and retain 100% of the remaining "time value" in the ESOs.You would have terminated about 40% of your alignment with Appleshareholders and still assume a substantial risk in Apple stock.You willhowever, have no broad market risk.If the stock is below $600 on Jan 20, 2014 the net gain on the sale of the callswould be $56,280, because you would be able to deduct the loss carry forwardagainst the gain from the options sale.--------------------------------------------------------------------------------------------------------If both the S&P 500 and Apple were unchanged on Jan 2014, the value of thesell calls positions would be $56,280 plus the value of the unexercised ESOs.The value of the S&P 500 position is $143,550.
  • If both positions were, down 25 % in Jan 2014 the following would be the result.Apple would be trading at $420.75 and the ESOs would be valued at $161,000,plus there was an after tax gain of $56,280 on the calls sold..The S&P 500 would be trading at 958 making the $143,550 have a value of$107,662.------------------------------------------------------------------------------------------------------If both went up 25%, Apple would be trading at $701.25 making the ESOs equal$401,250 plus the remaining time premium of $14,000 but the sale of the six callswould have caused a loss of $3720.The $143,660 in the S&P 500 index would equal $179,575.As can be seen in all of the circumstances outlied above, the sale of calls versuspremature exercises, sell and diversify is far superior.If the call seller wished to protect against extreme moves he/she could buy a smallamount of puts and sell fewer calls. This would reduce the profits if the stock madejust small percentage moves. Ajustments to the positions, after the inital trades,can also be made to create even better results that those shown.
  • In Summary, the larger the "time value" remaining in the ESOs, the greater thecase becomes for risk reduction and the greater the case is for selling callsand/or buying puts..Those advisers who do not understand the merits of selling calls or buying putsto a lesser extent, are not qualified to give advice on how to handle your equitygrants. They should restrict their advice to selling whole life insurance orannuities.Those advisers who do understand the superiority of selling calls and refuse toadvise doing so are violating their fiduciary duty and are setting themselves upto be sued or brought to arbitration. Those who endorse the prematureexercise, sell and diversify strategy in articles or books are accessories beforethe fact to violations of 10 b-5 which applies to deceipt and misrepresentationsin connection with the sale or buy of a security.John Olagues504-875-4825olagues@gmail.com
  • .In the above four slides we demonstrated a choice of management strategiesfor an employee holding ESOs on Apple stock on June 1, 2012 with APPLetrading for $561.Since then, Apple stock has increased $21 to $582 on June 22, 2012The Jan 2014 calls with a strike price of $600 are down $.80 trading at $93.The S&P 500 has increased from 1278 to 1335 or 4.46%, equally an increaseof $6402 for the diversified $143,000The value of the 1000 ESOs have increased about $19,000.So the advantage of the sale of the 6 calls versus the early exercise sell anddiversify is $13,000 in just 3 weeks, with less total risk. I will keep readersappriaised of the results periodically.
  • . At 11: A.M. CST, July 3, 2012 Apple is trading at $599.50 up 38.50 x 1000 = $38,500 for the 1000 shares. The six calls are trading at101.50 therefore losing 7.80 x 6 = $4,680 -------------------------------------------------------- The $143,000 that was "diversified into the S& P 500 had increased 7.6% or $10,860 ----------------------------------------------------------- So the strategy of betting against the company stock and betting on the broad market better known as, "early exercise, sell company stock and diversify" would be far behing the strategy of selling calls by the following amount in just one month. ($38,500 x 92%) - $4,680 - $10,860 = $19,880 This is just a further example of Wealth Managers having two choices 1. advise selling calls and/or buying puts 2. Violate their Fiduciary Duties and advise premature exercises, sell and diversify.
  • .On July 6, 2012, Google closed at $605.88 up $44,880 on the 1000 sharesfrom $561, making the employee stock options to buy 1000 shares at $300 up$41,289.00 in value from June 1, 2012.The 6 calls that were sold for $9380 each on June 1, 2012 were trading for$10,400 each giving a loss of $6120 in total for the 6 calls sold.The diversified investments on the S&P 500 index was up 6% from the June 1,2012 price of $1278 to $1354.80, making the value of the diversifiedinvestments up $8580.So below is how the results compare so far.A) Covered calls versus ESOs gives +$41,289 - $6120 = + $35,169 for thelong ESOs and short 6 calls since June 1, 2012B) Diversified investments + $8580 since June 1, 2012------------------------------------------------------------------------------------------------------The gain from selling calls is almost 300% more than early exercise, sell anddiversify.
  • .On the close of July 13, 2012, Apple was trading for $604.97 giving an increaseof $40,012 on the 1000 ESOs. The Jan 2014, calls with ex.pr. of $600 were trading for $102.70, showing aloss of $5340 on the 6 calls.The net equals $40,012 - $5340 = $34,672.On the other hand, the gain on the diversified porfolio is $8946. Making thedifference $34,672 - $8946 = $25,726.
  • .At 9: 44 EST on July 20, 2012, Apple was trading for 613.The six Jan 2014 calls that were sold for $9380 each were trading for $105.00,giving a loss of $6900.The value of the 1000 ESOs with the exercise price of $300.00 increasedapproximately $48,000. The net increase in value is $ 41,100.Had the 1000 ESOs been exercised, the stock sold and the net diversified,there would have been an investment in the S&P 500 of $143,500, which hasincreased by $10,100.------------------------------------------------------------------------------------------------So the comparison of the two strategies show the sell calls strategy ahead ofthe early exercise, sell , and diversify strategy by $31,000.00 on July 20, 2012.And there is still a substatial alignment between the grantee and the company.The early exercise, sell and diversify strategy is essentially a bet against thecompany and bet on the broad market with the money remaining after forfeitureof "time value" and paying an early tax.
  • .On July 31 at 12:00 Central Standard Time, Apple stock was trading for $609.49.The calls that we sold are trading at $98.30. This makes the gains on the stock tobe equal to $48,490 and the gain on the ESOs since the stock was at $561 to beequal to $44,126.The loss on the 6 calls sold would be $2700 making the net gain equal to $41,426.The gain on the two Apple positions is about $30,000 more than the gain from theS&P 500 Index from when it was trading for $1278.The difference is much greater with the sell calls strategy.
  • .On August 6, 2012 at 10:07 CST.Apple was trading at $622.05 and the Jan 2014 calls with a $600 ex.pr. weretrading for $104.35.So the stock is up $61,000 and the 1000 ESO are valued at approximately$56,700 higher than when we sold the 6 calls at $9,380 each.Therefore the Apple positions are valued as below:ESOs are up $56,600Calls are up $6,330Net gain on the Apple covered write is $50,270But the diversified position is up $14,000The selling calls versus the ESOs have earned $36,270 more than thediversified position and with less risk.
  • . On August 13, 2012 at 9:56 A.M. CST. Apple was trading for $627.15, and the exchange traded calls that have a strike price of $600 expiring in January 2014 were trading at $104.80. The SPX 500 was trading for 1400. So the 1000 shares were up $67,150 from $561 with the ESOs to buy the stock at $300 going up $61,700. The the six calls that were sold are losing $1100 each or $6600 in total. This makes the gain on the summed Apple positions equal to $55,100. On the $143,550 that was invested in the SPX 500 after exercise and sale, there is a 9.7% gain equal to $13,700. So the gain for the hedged Apple positions were better off compared with the early exercise sell and diversify strategy by $41,400. These are the results with Apple stock up about 11% and the SPX 500 up about 9.7%. Why would anyone promote the early exercise, sell and diversify strategy if they have the interests of the clients as primary because it certainly is not in the clients best interest to do so.
  • .On August 31, 2012, Apple closed at $665.24, showing an increase of $104.24since we started the camparison. The ESOs with an exercise price of $300, withan average delta of .96, increased about $99.50.The January 2014, $600 calls last traded at $135.10, giving a $41.30 loss to thesellers of the calls at $93.80.The SPX 500 increased about 10%, giving a $14,500 increase to the "diversifier".--------------------------------------------------------------------------------------------------So the 1000 ESOs increased in value by $99,500 and the sale of the 6 callsshowed a loss of $24,780. So the summed gain is $74,720On the other hand the SPX 500 made only $14,500.Therefore the difference is $60, 220.00 to the seller of calls versus the AppleESOs compared to the premature exercise, sale and diversify strategy. And therisk was less with the Apple positions than with the "diversified" SPX 500.The benefits of selling calls versus "diversifying" is so strong that advisers whorefuse to promote the strategy violate their fiduciary duty to their clients.