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This is the third article in a new series of options articles that I will be writing on Apple (NASDAQ:AAPL). Apple is a very unique company due its combination of size ($325B), earnings growth rate (75%), and volatility (1.4β). This presents an exceptional opportunity for investors to capitalize on both its long-term capital gain prospects and short-term option premiums. For reference, please view the first and second articles in the series to fully understand the strategy and its strong potential returns.

A brief recap of this week in Apple: Up $8.96 (2.6%)

This was a very eventful week for Apple investors as there was a substantial amount of both news and rumors for the company, punctuated with the release of the Verizon (NYSE:VZ) iPhone. The Wall Street Journal ("WSJ") is “confirming” rumors that Apple has begun production of the iPad 2; however, introduces the twist that the next version appears to be only an incremental improvement. If this proves to be true then this is a significant piece of negative news compared to widespread expectations that the next iPad would have a retina display like the iPhone 4. This feeds directly into the rumor that Apple will release an “iPad 2.5” in the fall of 2011. I will discuss this topic in a separate article in the early part of this week so please keep your eyes open for an in-depth analysis of this topic.

I believe that any detrimental news this past week was more than offset by the WSJ reporting that Steve Jobs is still very active with Apple despite his medical leave from the company. Investors can sleep a little easier knowing that Jobs is still in charge. As I said last week, with Apple trading very close to a new all-time high, I would not be surprised to see the stock pull back by a few percent in a week as investors understandably take profits. With both Bloomberg and the WSJ picking up the iPhone Nano story, there may be some truth to yet another perpetual rumor. This would be yet another revenue driver for a company that has had so much success thus far. Aside from an unexpected unfavorable news event, I expect Apple to remain at least unchanged this week.

Below I present three possible scenarios and the potential returns for the February 19 monthly options (Source: TD Ameritrade). The first scenario represents a very negative outlook for Apple the next week while the final two scenarios are more realistic in my opinion. As a general rule, selling calls with higher strike prices has more potential return but more risk due to the lower (or lack of) downside protection. For more information on the fundamentals of covered calls, read this excellent article on Investopedia.

Scenario 1: AAPL Closes at $341.22 (Down 5%)

Strike

Price

Return

Return %

Annualized

Downside Protection

345

$14.40

($3.56)

-0.99%

-72.33%

3.95%

350

$9.70

($8.26)

-2.30%

-167.86%

2.56%

355

$5.50

($12.46)

-3.47%

-253.22%

1.16%

360

$2.35

($15.61)

-4.35%

-317.24%

N/A

365

$0.71

($17.25)

-4.80%

-350.57%

N/A

Scenario 2: AAPL Closes at $359.18 (Unchanged)

Strike

Price

Return

Return %

Annualized

Downside Protection

345

$14.40

$0.22

0.06%

4.47%

3.95%

350

$9.70

$0.52

0.14%

10.57%

2.56%

355

$5.50

$1.32

0.37%

26.83%

1.16%

360

$2.35

$2.35

0.65%

47.76%

N/A

365

$0.71

$0.71

0.20%

14.43%

N/A

Scenario 3: AAPL Closes at $355.59 (Down 1%)

Strike

Price

Return

Return %

Annualized

Downside Protection

345

$14.40

$0.22

0.06%

4.47%

3.95%

350

$9.70

$0.52

0.14%

10.57%

2.56%

355

$5.50

$1.32

0.37%

26.83%

1.16%

360

$2.35

($1.24)

-0.35%

-25.24%

N/A

365

$0.71

($2.88)

-0.80%

-58.57%

N/A

Based upon the details presented above, I am of the opinion that executing a buy-write on AAPL and selling the February 19 355s is the best strategy due to its risk-return profile. If you are uncomfortable with this level of risk, I would suggest utilizing the 350s. Conversely, to increase potential returns, the 360s may be a better choice for your individual strategy.

Disclosure: I am long AAPL (with Feb 19 360 Covered Calls written) and VZ.

Source: Using Options to Profit From Apple Rumors