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This is the fifth article in a new series of options articles that I will be writing on Apple (AAPL). Apple is a very unique company due to its combination of size ($320B), 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, third, and forth articles in the series to fully understand the strategy and its strong potential returns.


A brief recap of this week in Apple [Up $6.01 (187%)]:

  • AAPL Delays: iPhone 5 for September, iPad 2.0 for June (Computer WorldFeb. 22)
  • AAPL Delays: *REFUTED* (Reuters Feb. 22)
  • NPD: Mac Sales Up 20% Year-over-Year (BGRFeb. 22)
  • FTC Reviewing iTunes Purchasing Practices (Washington Post Feb. 22)
  • Investors Vote Against Apple Disclosing CEO Succession Plan (Wall Street Journal Feb. 24)
  • Study of CEO Death's Impact on Stocks (Marketwatch Feb. 25 )
  • iPad 2 to Potentially Be Available Next Week (Apple InsiderFeb. 25)
  • Verizon (VZ) iPhone Susceptible to “Death Grip” (Consumer Reports Feb. 25)
  • Verizon CEO: iPhone Is Company’s Best Seller Ever (Wall Street JournalFeb. 25)
  • Jonathan Ive Rumored to Be Potentially Moving Back to UK (TUAW Feb. 27)

The events of the early part of this past week reaffirm the importance of reading technology blogs and understanding rumors. Apple declined significantly upon two rumors regarding product delays that were later disproved when Apple invited the media to its iPad event on March 2nd. If investors did not see these rumors they would not know why the stock declined so quickly and be unable to respond intelligently. Apple also released its refreshed MacBooks on Steve Jobs’ birthday, providing another catalyst for sustained earnings growth. Much of the other news this past week should not have a significant impact on the stock because investors have largely expected these developments. The FTC investigation was generally not expected; however, the scope of the probe is very limited. As a result, any forced changes should be minimal.

In my opinion one of the biggest news stories that is flying under the radar involves Jonathan Ive. Mr. Ive is the lead designer behind most of Apple’s hit products dating back to the iMac. If the early reports prove to be true and Ive wants to reduce his involvement with Apple, this would be very worrisome. If Apple’s stock has a “Steve Jobs premium” then it certainly should have a “Jon Ive premium.” In conjunction with the iPad launch on March 2 this will be another interesting week for Apple investors. As a covered call seller, remember my motto: embrace the volatility!

Below I present three possible scenarios and the potential returns for the March 4 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 of loss 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 $330.75 (Down 5%)

Strike

Price

Return

Return %

Annualized

Downside Protection

335

$14.40

($3.01)

-0.86%

-63.07%

3.78%

340

$10.05

($7.36)

-2.11%

-154.28%

2.34%

345

$6.25

($11.16)

-3.20%

-233.95%

0.91%

350

$3.30

($14.11)

-4.05%

-295.81%

N/A

355

$1.45

($15.96)

-4.58%

-334.60%

N/A

Scenario 2: AAPL Closes at $348.16 (Unchanged)

Strike

Price

Return

Return %

Annualized

Downside Protection

335

$14.40

$1.24

0.36%

26.00%

3.78%

340

$10.05

$1.89

0.54%

39.63%

2.34%

345

$6.25

$3.09

0.89%

64.79%

0.91%

350

$3.30

$3.30

0.95%

69.19%

N/A

355

$1.45

$1.45

0.42%

30.40%

N/A

Scenario 3: AAPL Closes at $343.5 (50 Day SMA)

Strike

Price

Return

Return %

Annualized

Downside Protection

335

$14.40

$1.24

0.36%

26.00%

3.78%

340

$10.05

$1.89

0.54%

39.63%

2.34%

345

$6.25

$1.59

0.46%

33.34%

0.91%

350

$3.30

($1.36)

-0.39%

-28.52%

N/A

355

$1.45

($3.21)

-0.92%

-67.31%

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.

Apple March 4 Option Sensitivity
(Click to enlarge)

Based upon the details presented above, I am of the opinion that executing a buy-write on AAPL and selling the Mar. 4 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. In a normal week I may have favored the 350s but I would like to retain the potential upside that could be associated with unexpected iPad 2 features being announced.

Disclosure: Author holds a long position in AAPL and VZ. Author plans to sell AAPL Mar. 4 355 Covered Calls.

Source: How to Trade Options for the iPad 2 Launch