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This is the fourth 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, second, and third articles in the series to fully understand the strategy and its strong potential returns.

A brief recap of this week in Apple [down $6.23 (-1.7%)]:

  • Apple Launches Subscriptions on App Store (Apple February 15)
  • Steve Jobs Rumored to Be Receiving Cancer Treatment (Radar February 16)
  • Initial Verizon (NYSE:VZ) iPhone Retail Sales Disappointing (Boy Genius Report February 16)
  • NFC Tech in iPhone 5 “Confirmed” By Deutsche Telekom (Boy Genius Report February 17)
  • Apple Rumored To Be Planning Retail Store in Grand Central Station (Cult of Mac February 17)
  • New iTunes Subscription Plan Draws Antitrust Talks (Wall Street Journal February 18
  • MacBook Line Refresh Expected Next Week (Apple Insider February 18)
  • Apple Expected To Be Announcing New High-Speed Technology (CNet February 19)
  • Apple Called “Short of the Century” on CNBC (CNN Money Fortune February 20)

For the second consecutive week there was a substantial amount of Apple news. As we get closer to new product launches (MacBooks, iPad, and iPhone), there will be even more rumors surfacing. I try to only highlight high profile news and rumors but I strongly urge you to read the above articles to judge for yourself. For example, I put very little faith in the alleged pictures of Steve Jobs at the cancer treatment facility. On the other hand, I believe that the MacBook refresh next week is highly likely. Regardless of whether these all prove to be true, it is critical for investors to at least read the stories to know what is moving the stock.

The biggest news story of the week revolved around the new iTunes subscription plan and the related question of whether Apple is exercising monopoly power. No one knows how successful the new subscription plan will be but it certainly introduces more volatility into the stock. As a covered call seller this is great news because it will lead to higher premiums. Remember, embrace the volatility!

Below I present three possible scenarios and the potential returns for the February 25 weekly 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 $333.03 (Down 5%)

Strike

Price

Return

Return %

Annualized

Downside Protection

340

$12.50

($5.03)

-1.43%

-104.70%

3.01%

345

$8.65

($8.88)

-2.53%

-184.87%

1.59%

350

$5.40

($12.13)

-3.46%

-252.55%

0.16%

355

$3.00

($14.53)

-4.14%

-302.53%

N/A

360

$1.53

($16.00)

-4.56%

-333.14%

N/A

Scenario 2: AAPL Closes at $350.56 (Unchanged)

Strike

Price

Return

Return %

Annualized

Downside Protection

340

$12.50

$1.94

0.55%

40.40%

3.01%

345

$8.65

$3.09

0.88%

64.35%

1.59%

350

$5.40

$4.84

1.38%

100.79%

0.16%

355

$3.00

$3.00

0.86%

62.47%

N/A

360

$1.53

$1.53

0.44%

31.86%

N/A

Scenario 3: AAPL Closes at $352.5 (10 Day SMA)

Strike

Price

Return

Return %

Annualized

Downside Protection

340

$12.50

$1.94

0.55%

40.40%

3.01%

345

$8.65

$3.09

0.88%

64.35%

1.59%

350

$5.40

$4.84

1.38%

100.79%

0.16%

355

$3.00

$4.94

1.41%

102.87%

N/A

360

$1.53

$3.47

0.99%

72.26%

N/A

Additionally, if you would like even more information, I have prepared a sensitivity analysis for absolute return and percent returns, respectively. After studying the information above, these two charts make it easy to pick a strike price based on where you believe Apple will close on Friday.

click to enlarge images

Apple February 25 Sensitivity Analysis

With Apple down almost two percent last week, choosing a strike price becomes a little more difficult than usual. Based upon the 14-day RSI graph below (source: TD Ameritrade), it appears that there is some support around the current $350 level.

Apple Feb 25 14 Day RSI

Based upon the details presented above, I am of the opinion that executing a buy-write on AAPL and selling the February 25 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.

Source: Using Options to Profit From Apple Pessimism