Assumptions:

Let's suppose that you had been granted 5000 Apple

Restricted Stock five years ago which vested three

years ago when the stock was 30. You paid the tax

on the stock and did not sell.

You also were granted 10,000 Employee Stock

Options 3 1/2 years ago with an exercise price of 27.

These options 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. At some firms which

charge the minimum margin requirements, the writer

could remove all of the proceeds of the sale of the calls

and still have substantial excess margin. In fact, with the

new portfolio minimum margin requirements, the writer

of the 150 calls would be required to own only 2000 shares

fully paid for in order to satisfy initial margin requirements.

No taxes or interest payments would be accessed upon

the withdrawal of the $243,000

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

+ 6150.

There would have been no "time premium forfeited" back to the

company. There is no current tax liability. There is no additional

margin required to initiate this position. The deltas are still

long 6150.

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

liquidations 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 and can be taken now or

used in future years.

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. If the ESOs are Qualified ESOs, the stock

should be held and used as margin collateral.

Efficient hedging by selling Apple listed long term out of the

money calls will result in 50-100% more earning in these

circumstances with Apple than the naive startegy 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 some slightly

out of the money puts in lieu of writing as many calls.

Apple Update

Stock is trading abour $109.6 and the Jan 2009, 110 calls

are trading at $22.80.

The value of the three positions increased about $60,000.00

with a unliquidated loss on the calls sold of about $97,000.

So lets buy 50 of those back and sell 50 of the Jan 2009,

120s, giving a liquidated $32,400 short term capital loss and

making the position a bit more bullish. The spread could be

bought for about $430 x 50. Alternatively (or in addition to)

you could buy 70 Jan 2009 110 calls back and sell 50 of the

Jan 2009 90s giving some positive gammas. Both of these are

margin reducing and capital loss "harvesting" trades.

Up date on Apple May 31, 2007 stock = $120

Lets assume that the optionee took the earlier suggestion to

buy 50 call verticals (110x120) for 430 and/or bought another

70 Jan 2009 110 calls against the sale of the 50 Jan 2009 90

calls.

He can now buy back the 30 Jan 2009 110 calls and sell

30 Jan 2009 130 calls, again "harvesting" capital

losses and picking up some long deltas. That's what we would

recommend.

Update June 7, 2007 AAPL trading for 123.65 at close.

The Jan 2010 calls are now trading. We suggest buying 50%

of your shorts in the Jan 2009 , 120 calls and selling an equal

number of Jan 2010, 140 calls for a credit of 50 cents.

Again we "harvest" capital losses and hold on to unliquidated

gains. This also picks up some long deltas and reduces

margin requirements. The implied volatility increase and the

increase in interest rates has added value to the ESOs

and the listed calls.

Update June 12. AAPL trading at 117

Close out any losing position shorts in Jan 2009 calls for

"Tax Harvesting" purposes other than the Jan2009, 90 calls.

This means buying the Jan 2009 130's, or the Jan 2009

120's and selling simultaneously the Jan 2010, 130 's and the

Jan 2010, 120 calls. Enter the orders as a spread with a

limit which gives a slight theoretical edge.

Update AAPL July 13, 2007 AAPL = 137.7

Buy in all Jan 2009, 130 calls and sell all Jan 2010, 150

calls for 30 cents credit.

This adjustment "harvests" tax losses and adds a small

amount of positive deltas. I dentify the sale versus the

ESOs as an "identified starddle"

Implied Volatility Increase

The implied volatilities on the Apple calls have increased

making it such that the profits on the three positions

combined were less than expected if the volatilities stayed

the same.

Straddle Rule

Some pundits who claim expertise in this area will say that

the straddle rule disallows the deduction of the losses.

Well, that is not true. Even if the starddle rule applied on

the sales of calls versus the ESOs (which I do not believe

it would), it would not have applied to the sales of calls

versus the long stock as those are "qualified covered" calls.

The worse case would be that 2/3 of the loss would be

delayed a year or the 2/3 loss would increase the basis

in the ESOs. If one believes that the straddle rule will

apply to selling calls versus ESOs, then he should designate

the sale together with the ESOs is a "identified starddle"

making it such that the losses on the calls sold are used to

increase the cost basis of the ESOs.

Mismatched tax losses and gains

Some other pundits claim that there will be a mismatching of

losses, with the losses on the listed calls not deductible

against the ordinary income from the ESOs. These same

pundits are the ones who claim that the straddle rule applies.

If the starddle rule applies and there is an identified starddle,

the loss on the listed calls merely increases the cost basis

of the ESOs.This means that the losses and gains are

matchable if their idea that the straddle rule applying is

correct.

John Olagues

P.S. Since April 27, 2007 when this article started, there has been a general rise in the implied volatility of many stocks. Apple's implied volatility has risen from perhaps 33 to 41. There has also been a rise in general interest rates. Given the above factors, the value of the Apple listed calls have risen in both theoretical and market values. If a person had sold calls as described in this article, reducing his deltas accordingly, but remaining substantially long, he would have still expected a large rise in total value of his combined positions with the stock rising as it did.

However, the rise would have been substantially less due to the rise in the implied volatility and interests rates, although the theoretical value of the ESOs would have risen somewhat as a result of the rise in volatility and interest rates.

The lesson here in that as time passes, volatilities and interests rates do change thereby affecting the value of both the ESOs and the listed calls. That is why, the prudent approach to hedging in the start relatively small and increase positions as time passes.

P.P.S. I just posted an attachment which shows when Steve Jobs thinks is the best time to exercise ESOs.

He exercised 120,000 options with a strike priceof $5.70 on the very last day of the life of the options. He did not forfeit any time premium nor did he pay an early tax. That is the way everyone should do it.

At least Jobs has one advisor who somewhat understands ESOs.