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This is the sixth article in a series on Apple (NASDAQ:AAPL) option strategy. Apple is a very unique company due its combination of size ($330B), 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, forth, and fifth articles in the series to fully understand the strategy and its strong potential returns.

A brief recap of this week in Apple [Up $8.76 (2.5%)]:

  • Apple Introducing Small Business Tech Support (Apple Insider Feb. 28)
  • Bernstein Research's Interview With Apple's Management Team (Forbes Feb 28.)
  • How Apple Contains Costs (Forbes Mar. 2)
  • iPad 2 Announcement Details (Apple Insider Mar. 2)
  • Analysis of Steve Jobs' Appearance at iPad 2 Launch (Apple Insider Mar. 2)
  • BBM Possibly Being Released For iPhone (BGR Mar. 2)
  • Roundup of Analysts' iPad Opinions (Forbes Mar. 3)
  • Best Buy Rumored to Give iPad To Store Associates (Forbes Mar. 4)

The news this week was concentrated on the iPad launch on March 2nd and it largely lived up to expectations. Aside from the lack of the retina display, the iPad 2 has all of the features necessary for Apple to maintain its market dominance. With the Motorola (MMI) Xoom launching this week at $799, a popular theme of authors has been to chronicle why no one has been able to match Apple on price in the tablet market. The consensus top three reasons are: Apple’s retail network, long-term component contracts, and internal development of processors. Jason Perlow at ZDNet summarizes the current situation nicely:

"The calculus is really a no-brainer. Either spend $499 for a 16GB iPad 2 with over 65,000 tablet-optimized optimized applications, or spend $799 for an unlocked 3G device which is 4G upgradeable, or commit to a 2-year contract with Verizon (VZN), on a completely unproven tablet platform."

Almost overshadowing the iPad announcement was Steve Jobs’ presence at the keynote. Jobs appeared as healthy as he did at his last public appearance, thus reaffirming to me that he is still heavily involved with Apple. On the topic of Apple’s management, the Bernstein interview posted on Forbes includes some rare insights into Apple’s future plans. The highlights include:

  • iPhone "halo effect" is driving sales growth in other products, especially in emerging markets.
  • Apple is open to the possibility of lower priced iPhones and/or prepaid phones.
  • Apple will continue to use surplus cash "to secure supplies of key components."

With the uncertainty of the iPad 2 launch behind us, I anticipate Apple resuming its climb and setting a new all-time high in the near future.

Below I present three possible scenarios and the potential returns for the March 11 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 $342 (Down 5%)

Strike

Price

Return

Return %

Annualized

Downside Protection

350

$11.10

($6.90)

-1.92%

-139.92%

2.78%

355

$7.15

($10.85)

-3.01%

-220.01%

1.39%

360

$4.00

($14.00)

-3.89%

-283.89%

0.00%

365

$1.88

($16.12)

-4.48%

-326.88%

N/A

370

$0.84

($17.16)

-4.77%

-347.97%

N/A

Scenario 2: AAPL Closes at $360 (Unchanged)

Strike

Price

Return

Return %

Annualized

Downside Protection

350

$11.10

$1.10

0.31%

22.31%

2.78%

355

$7.15

$2.15

0.60%

43.60%

1.39%

360

$4.00

$4.00

1.11%

81.11%

0.00%

365

$1.88

$1.88

0.52%

38.12%

N/A

370

$0.84

$0.84

0.23%

17.03%

N/A

Scenario 3: AAPL Closes at $355 (50 Day SMA)

Strike

Price

Return

Return %

Annualized

Downside Protection

350

$11.10

$1.10

0.31%

22.31%

2.78%

355

$7.15

$2.15

0.60%

43.60%

1.39%

360

$4.00

($1.00)

-0.28%

-20.28%

0.00%

365

$1.88

($3.12)

-0.87%

-63.27%

N/A

370

$0.84

($4.16)

-1.16%

-84.36%

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 AAPL Weekly 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. 11 360s is the best strategy due to its risk-return profile. If you are uncomfortable with this level of risk, I would suggest utilizing the 355s. Conversely, to increase potential returns, the 365s may be a better choice for your individual strategy. As many great SA users have pointed out, an alternative strategy is to sell out-of-the-money puts on Apple and collect the premium without having to purchase the stock outright.

Disclosure: Author holds long positions in AAPL and MMI. Author plans to sell AAPL Mar. 11 360 Covered Calls and Cash Secured Puts.

Source: How to Trade Options for iPad 2 Exuberance