An Options Play for the Apple-China Mobile Story

Jun.27.11 | About: Apple Inc. (AAPL)

Apple (AAPL) is a unique company due its size ($300B), 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. I have recommended options strategies on Apple since 2010 with tremendous results. For reference, please view the first and other articles in the series to fully understand the strategy and its strong potential returns.

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AAPL Option ChainClick to enlarge

A brief recap of this week in Apple [up $8.99 (2.8%)]:

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AAPL Weekly ChartClick to enlarge

Apple exactly erased its losses from the previous week and is unchanged in the last two week period. Now that Apple has officially delayed the iPhone 4S/5 launch, the rumors are really starting to heat up. It is important now to focus on the more legitimate rumors that are either confirmed by legitimate sources or involve outlets with track records of success.

The story to focus on is the possibility of Apple supporting the iPhone 5 on China Mobile (NYSE:CHL) this year. Not only does this lend support to a more revolutionary iPhone 5 rather than iPhone 4S, it also opens up another tremendous market to Apple. This is further supported by sightings of COO Tim Cook at China Mobile’s headquarters. This is an example of the type of analysis that is necessary when deciding to trust Apple rumors. Also, keep a keen eye on Google’s FTC investigation. Not only is Google a key competitor, but this could signal increased antitrust involvement.

Below I present three possible scenarios and the potential returns for the July 1 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.

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AAPL Sensitivity AnalysisClick to enlarge

With this information, executing a buy-write on AAPL July 1 (Weekly) 325s is the optimal risk-return strategy. If you are uncomfortable with this approach, I suggest utilizing the 320s. Conversely, to increase potential returns, the 330s may be more appropriate. An alternative approach is to sell out-of-the-money 320 puts and collect the premium without having to purchase the stock outright. Note that if the stock declines to the strike price, you are obligated to buy the stock (or closeout the position). As I have detailed in the past a 325 short straddle can work. However, I do not feel that the potential return of $6.50 compensates for the risk with the market in such a tailspin.

Disclosure: I am long AAPL, GOOG.