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This is the sixteenth article in a series on Apple (AAPL) option strategy. Apple is a very unique company due to its combination of size ($315B), earnings growth rate (95%), 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 $7.36 (-2.1%)]:

  • Apple Declared Most Valuable Brand (May 9 Financial Times)
  • Apple Chooses Nuance Over Microsoft (May 9 TechCrunch)
  • HP Introducing Tablet in June (May 10 Wall Street Journal)
  • Google Introduces Music Beta To Compete With Future iCloud (May 11 Google)
  • Amazon To Introduce New Kindle To Rival iPad (May 11 Consumer Reports)
  • Microsoft Acquires Skype For $8.6B (May 11 Wall Street Journal)
  • Is Apple Facing Share Price Manipulation? (May 12 CNNMoney)
  • App Store Developers Facing Patent Suits (May 13 Apple Insider)
  • iPhone and iPad Dominating Enterprise Adoption (May 13 Apple Insider)
  • Next iPhone Rumored To Be iPhone 4S And Operate on T-Mobile/Sprint (May 13 Forbes)
  • Eastman Kodak Wins ITC Ruling Against Apple (May 13 Bloomberg)
  • RIMM Recalls Playbooks Sold at Staples (May 14 Engadget)

In the face of mixed news, Apple hit a one-month low thereby fully erasing the recovery after its April earnings. The past two weeks included considerable speculation of new iPad competitors, which may have frightened investors, but Apple has numerous positive catalysts, notably iCloud and iPhone 5. Apple currently has a near insurmountable lead in the tablet market and may have a natural monopoly. Despite headwinds, I see pessimism dominating for the remainder of May, thus Apple trading in a narrow range. Stay confident because Apple is trading at its lowest PE since Lehman Brothers was in business. After adjusting for cash, the PE is the low teens. Owning Apple while simultaneously selling calls and puts against a resistance level can yield robust profits.

Below I present three possible scenarios and the potential returns for the May 21 monthly 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 - (Click charts to enlarge).
AAPL Apple Option Chain
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.

AAPL Apple Sensitivity Analysis
With this information, executing a short straddle on AAPL May 21 340s while long the stock is the best strategy due to the risk-return profile. If Apple closes above $340 the return is $7.50. If you are uncomfortable using a short straddle, I suggest a buy-write on the 340s. An alternative related strategy is to sell only the out-of-the-money puts and collect the premium without having to purchase the stock outright; the 335s and 340s are attractive for this purpose. Selling either covered calls or puts is simply isolating the legs of the short straddle to assume less risk. Note that if the stock declines to the strike price, you are obligated to buy the stock (or closeout the position).

Disclosure: Author holds a long position in AAPL and is short May 21 360 Calls.

Source: Bet on Apple to Keep Dominating the Tablet Market