Apple to Benefit From Playbook's Premature Launch

Apr.18.11 | About: Apple Inc. (AAPL)

This is the twelfth article in a series on Apple (NASDAQ:AAPL) option strategy. Apple is a very unique company due to its combination of size ($300B), 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 other articles in the series to fully understand the strategy and its strong potential returns.

A brief recap of this week in Apple [Down $7.17 (-2.1%)]:

  • Concerns Over Tech Company Salaries (Apr. 11 Marketwatch)
  • Amazon Launching Cheaper Ad Supported Kindle (Apr. 11 Wall Street Journal)
  • iPhone 5 Rumored For Production in September (Apr. 12 Apple Insider)
  • RIMM's Playbook Not Ready for Primetime – Mossberg (Apr. 14 Wall Street Journal)
  • Apple Begins Production of White iPhone 4 (Apr. 14 Reuters)
  • Summary of Apple Pre-Earnings (Apr. 15 Marketwatch)
  • iPhone 4 Nearly Top Camera Used on Flikr (Apr. 17 TechCrunch)
  • iPad 2 Now on Sale at Toys-R-Us (Apr. 17 Toys-R-Us)

Scenario 1: AAPL Closes at $311.25 (Down 5%)

Strike

Price

Return

Return %

Annualized

Downside Protection

315

$16.40

$0.02

0.01%

0.41%

3.85%

320

$12.85

($3.53)

-1.08%

-78.69%

2.33%

325

$9.75

($6.63)

-2.02%

-147.76%

0.80%

330

$7.05

($9.33)

-2.85%

-207.92%

N/A

335

$4.90

($11.48)

-3.50%

-255.82%

N/A

Click to enlarge

  • Scenario 2: AAPL Closes at $327.63 (Unchanged)
  • Strike
  • Price
  • Return
  • Return %
  • Annualized
  • Downside Protection
  • 315
  • $16.40
  • $3.77
  • 1.15%
  • 84.00%
  • 3.85%
  • 320
  • $12.85
  • $5.22
  • 1.59%
  • 116.31%
  • 2.33%
  • 325
  • $9.75
  • $7.12
  • 2.17%
  • 158.64%
  • 0.80%
  • 330
  • $7.05
  • $7.05
  • 2.15%
  • 157.08%
  • N/A
  • 335
  • $4.90
  • $4.90
  • 1.50%
  • 109.18%
  • N/A
Click to enlarge

  • Scenario 3: AAPL Closes at $333.5 (50 Day SMA)
  • Strike
  • Price
  • Return
  • Return %
  • Annualized
  • Downside Protection
  • 315
  • $16.40
  • $3.77
  • 1.15%
  • 84.00%
  • 3.85%
  • 320
  • $12.85
  • $5.22
  • 1.59%
  • 116.31%
  • 2.33%
  • 325
  • $9.75
  • $7.12
  • 2.17%
  • 158.64%
  • 0.80%
  • 330
  • $7.05
  • $9.42
  • 2.88%
  • 209.89%
  • N/A
  • 335
  • $4.90
  • $10.77
  • 3.29%
  • 239.97%
  • N/A
Click to enlarge

Apple largely ignored positive news regarding the RIMM’s Playbook (RIMM) and tracked the market. Continuing the theme from last week, “the NASDAQ rebalancing appears to have outweighed any encouraging reports.” A cloud over Apple for the past few months has been the uncertainty surrounding the quality of the Playbook and the initial reviews have been unfavorable for RIMM. Invest like Warren Buffett and take advantage of the unfounded short-term Apple selling ahead of earnings and the rebalance. Apple has historically breezed past earnings estimates and this time should be no different. Apple is down approximately six percent the past few weeks and strong earnings should reverse the trend. With a “true cash” adjusted P/E of 16 I believe that Apple is a bargain, as reflected in option values.

Below I present three possible scenarios and the potential returns for the April 21 weekly options (Source: TD Ameritrade). The first scenario represents a negative outlook for Apple while the final two scenarios are more realistic in my opinion. As a general rule, selling calls with higher strike prices has greater potential return but additional risk of loss due to the lower (or lack of) downside protection. For more information on the fundamentals of covered calls, consult Investopedia.

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 April 21 Sensitivity AnalysisClick to enlarge

(Click chart to expand)

With this information, executing a buy-write on AAPL Apr. 21 325s is the best strategy due to the risk-return profile. If you are uncomfortable with this level of risk, I suggest utilizing the 330s. Conversely, to increase potential returns the 335s may be a better choice for your individual strategy. An alternative strategy is to sell out-of-the-money puts and collect the premium without having to purchase the stock outright; the 320s, 325s, and 330s are attractive for this purpose. Think about it: would you be willing to receive $5 to potentially be forced to buy Apple at $320? Note that if the stock declines to the strike price, you are obligated to buy the stock (or closeout the position).

Disclosure: I am long AAPL.