Apple Options: It Doesn't Have To Hurt

Jun.20.11 | About: Apple Inc. (AAPL)

Four weeks ago, I sold the $310/$315 June 18 put spread for a credit. How was I able to see into the future? The options market held the answer. On May 23, Apple’s (NASDAQ:AAPL) June 18 options gave you a sign that the stock would not go below $320 or above $370. If you recall my last article (here), selling the $320 puts and $370 calls gives you an 83% probability of having your options expire worthless, our goal. You will also note selling the $315 puts and the $375 calls brings our probability up to 98%. Below is a snapshot of AAPL’s June 18 open interest (OI) on May 23.

(Click charts to expand)
Click to enlarge

How Did I Use This Data?
On May 23, I sold the June 18 $310/$315 put spread for a credit of $0.70. AAPL was trading ~$332 at the time. Later that week the spread collapsed, losing ~70% of its value, a gain for me. I have some sort of intense aversion to taking early gains and prefer to let my options expire. It is prudent for you to take large gains when they come. You want the least amount of time exposure to mitigate risk.
Due to WWDC, I held off selling covered calls until the event as I thought the stock would run up. On June 6, the highest OI calls resided on the $350 strike. I chose to ignore this data and sell the $365 calls for $0.60 due to the extreme bullish bias I have toward AAPL. Once again, the options market proved me wrong as AAPL continued its slide away from the $350 strike, finishing the June 18 expiry at $320.26. I continued to follow AAPL down by rolling my $365 strikes to the $350 level for an additional $0.31 credit. They remained here until expiry as the $350 strike had the highest OI.
During the June 18 options cycle I took in $0.91 of risk-less credit against my long stock/LEAP collection and $0.70 of risk credit for a total of $1.61. I have repeated this process over the past 24 months approximately. I have taken in somewhere near $30 of credit during this period. In essence, my AAPL cost basis is now $30 lower than it originated. If I continue the strategy, maybe the market will pay me to buy AAPL.
Wealth Transfer: Which Side Are You On?
Below is an image of what wealth transfer looks like. I am not aiming at very short-term traders who play options daily and are profitable. I am trying to arm the average investor with an end game. Do not randomly buy front month options because you feel like AAPL is going to move. Hold AAPL for a long-term investment and use the option market in your favor. If you hold AAPL, you need to be selling calls to lower your cost basis. Become your own insurance company at zero risk to you. As you can see 383,718 contracts expired worthless, representing 38,371,800 shares option writers were liable for.
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If you are new to options, please arm yourself with knowledge before trading. If you understand options but have yet to sell them, start with selling covered calls.
Looking Forward
Bullish Cross’s Andy Zaky recently initiated a buy on AAPL; read the coverage (here). I agree with his forecast. You cannot add much more from a fundamental level, let us see what the options market says.
Turning to the June 25 weekly options, we can see the $320 puts have the highest OI. Friday saw the weekly put options trade in what seemed like chaos. There was volume at the $320 strike going low as the $285 strike. We will need to wait until Monday to see if much of that volume made it to OI or how much of it was panic driven. Note these options have only been trading for two days so they do not carry much weight. Looking to the more accurate July contract, we again see the $320 holds the highest put OI. This may change over time but as of now, this is the data.
Opinion On What Is To Come

If you look at the weekly option trading from Friday, it says either you will get your strong buy next week or Friday was our bottom due to panic. Using the July options, we see a recurring theme. The majority of traders are not looking for more protection than the $315/$320 area. It is my observation that the options market will start to strangle itself. If we have the $315/$320 area as our floor shown through options and AAPL stays around its current level, the call OI will continue coming down every week. This will cause a point of fusion where both call and put highest OI are on the same strike. Picture an elevator door that slides from right to left while closing. Puts are the stationary part of the elevator; the calls are the sliding door. They will eventually reach each other only to have someone hit the open button where the door soars open once again. This opening action will represent the stock price.

Does this contradict the statement that the options market controls AAPL? Once the stock breaks free from the options wrath it is tough to rein it back in as momentum and volatility take over.
So When Does All This Happen?
While it is futile to give exact dates, I am going to use logic as a course of action. July options expire the week before AAPL’s earnings. I imagine we will have to forgo another month of an options albatross. AAPL’s earnings will be around July 19. This is good fortune, as there will be no heavily weighted option expiry activity at that time. Mix an earnings catalyst with a possible self-fulfilling prophecy known as CNBC “buy tech in August.” We may get one heck of an AAPL rally come August as all three stars align:
  1. options market creates a breakout point
  2. fundamentals take over with AAPL trading at a 13 P/E vs. the markets 15 P/E
  3. The all mighty CNBC says -- “now you buy tech.”
Disclosure: I am long AAPL. At anytime I will initiate short call and short put spread