Stock Options To The Rescue! Apollo Group (APOL)
Today we’re looking at an option trade on Apollo Group to get back to breakeven after a huge decline in the stock.
Here’s what happened…
Apollo Group (APOL) reported fiscal third quarter earnings this week. The shares are up 10% to around $35.50 after earnings, but they’re down 39% from their 52-week high of $58.29.
Here’s the deal…
The leader in for-profit education beat analysts’ expectations last quarter but the results still weren’t good…
Analysts were expecting APOL to earn 97 cents per share. And the $1.20 per share they earned easily topped those expectations. However, EPS were down a whopping 25% from the same quarter last year.
And it was the same story for revenue growth. Revenue fell 9% from a year ago. The weak results were driven by a 13% decrease in enrollment.
At this point, falling revenue and earnings are the norm for APOL. And it’s hard to get excited about a better than expected quarter when the company’s revenue and earnings still shrank year-over-year.
Here’s the kicker…
Many investors have been suckered into investing in APOL as the stock sold off this year. They’ve been snared by the company’s low valuation and solid balance sheet.
But the sad truth is APOL is nothing more than a value trap.
Their business model has been wrecked by Federal regulations. And they don’t have a plan to return to growing the business.
APOL’s simply trying to stem the tide while Federal regulators watch their every move like a hawk waiting to pounce on wounded prey.
What’s more, cyclical downturns in the economy are usually good for education. People look to better their earning power with higher education in typical economic downturns.
But this downturn is different. We’re going on four years and counting since unemployment skyrocketed. And getting a better education doesn’t necessarily mean you can get a job or a better paying job in the current economy.
And when prospective students don’t believe the cost of the education will result in better employment prospects, there’s little chance APOL will return to growth in the next few years.
Here’s what to do now…
Let’s assume you thought APOL was a great stock at a cheap valuation at $40 per share back in March. So you invested $4,000 to buy 100 shares of APOL.
Unfortunately, APOL has continued to fall. At a current price of $35.50 per share, you’re down about 11% or $450.
Obviously this wasn’t the result you had hoped for. At this point, you need a dose of reality. You were sucked into the APOL value trap. And you should be happy if you can get out of the stock at breakeven.
The good news is we’ll likely see APOL trade modestly higher after the better than expected quarter. Let’s use this as an opportunity to use a call ratio spread to help you get back to breakeven so you can get out of the trade.
A 2:1 call ratio spread is executed by buying a call at a lower strike and selling twice as many calls at a higher strike.
Buy 1 APOL August 2012 $36 Call and Sell 2 August 2012 APOL $38 Calls.
Right now you can buy the $36 call option for $1.80 and you can sell the $38 call option for $0.90. So the spread doesn’t cost you anything to put on.
If APOL is trading at $38 when the options expire in August, both of the August $38 calls expire worthless… and the long August $36 call is in the money. The long call gives you a profit of $200. And your APOL stock has gained $250 moving from $35.50 to $38.
You total gain of $450 is equal to your total loss on the stock trade. But you’ve been able to recoup all of your losses at $38 instead of $40.
The downside is, if the stock rockets past $38 per share, you’re still only going to breakeven. All of the call options will be in the money. But in connection with the long stock position, they essentially cancel each other out. But you’ll still be out of the trade at breakeven and that’s our objective with APOL.
The good news is there’s no additional downside from this strategy. If APOL continues to fall, your losses will be exactly the same as if you had simply held the stock waiting for it to recover.
In my opinion, a call ratio spread is an ideal rescue strategy to get you out of APOL with a smaller upside move in the stock.
Good Investing,
Corey Williams
Category: Stock Options To The Rescue!
