An Options Strategy for Apple Ahead of Earnings

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

You need to buy Apple (NASDAQ:AAPL) before earnings. Apple is a unique company due its size ($335B), earnings growth rate (95%), and volatility (1.4β). I have recommended option strategies on Apple since 2010 with tremendous results. For reference, please view articles in the series here, here and here to fully understand the strategy and its strong potential returns.

(Click charts to enlarge)

AAPL Weekly ChartClick to enlarge

A brief recap of last week in Apple [Up $8.58 (2.4%)]:

  • iOS Users Have $100 of Content on Device – Switching Costs Rise (July 11 Apple Insider)
  • Apple Attempts to Block HTC Imports Over Patent Suit (July 11 Bloomberg)
  • China Telecom Plans To Offer iPhone to 100M+ in 2011 (July 12 Reuters)
  • Apple Accounts for 20% of all US Retail Growth in 2011 (July 13 USA Today)
  • Apple’s Marketshare Rises Above 11% (July 13 Apple Insider)
  • Amazon (NASDAQ:AMZN) Rumored To Release Tablet By October (July 14 Wall Street Journal)
  • Google (NASDAQ:GOOG) Posts Record Profits (Google+ July 14)
  • ITC Rules HTC Violated Apple Patents (July 16 Fortune)

Fresh at a new all-time high set at the close Friday, Apple is poised to report Q3 results on July 19th and the bar has been set high. Google just announced its highest quarterly revenue and that it is activating 550K Android devices per day. Apple’s consensus estimate is “for $24.92 billion in revenue and $5.80 per share in EPS.” The stock has rallied leading up to the quarter despite the lack of the iPhone 4S/5 but the best is still ahead of Apple. Next quarter should see the release of the iPhone 5, new Macbook Airs, and possibly even the oft rumored iPad 2.5/3. These are the reasons why you need to be long Apple through the summer and fall of 2011. As this past quarter proved, Apple is extremely volatile but the fundamentals do win out over the long run. WhisperNumber has a great analysis of Apple’s recent response to its earnings reports. I suggest being cautious this week but the robust call premiums are too hard to resist.

Below I present three possible scenarios and the potential returns for the July 22 weekly options (Source: TD Ameritrade). The first scenario represents a negative outlook for Apple while the final two scenarios are more realistic. 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.

AAPL Weekly Option ChainClick to enlarge

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 Sensitivity AnalysisClick to enlarge

With this information, executing a buy-write on AAPL July 22 (Weekly) 365s is the optimal risk-return strategy. If you are uncomfortable with this approach, I suggest utilizing the 355s or 360s. An alternative approach is to sell out-of-the-money 355 or 360 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 355 short straddle can be profitable but I suggest avoiding before volatile news.

Disclosure: I am long GOOG; plan to purchase AAPL and write 360 July 22 Calls.