What AA+ Means for Apple Options

Aug. 8.11 | About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) is a unique company due its size ($350B), earnings growth rate (125%) and volatility (1.3β). I have recommended option 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 Aug ChartClick to enlarge

A brief recap of this week in Apple - down $24.16 (6.1%):

  • Analyst Says China Telecom-Apple Deal “Imminent” (August 3 Apple Insider)
  • Time Planning to Release All Magazines for iPad (August 3 Reuters)
  • Apple on Legal Offensive Against Fake Apple Stores (August 4 Apple Insider)
  • Unauthorized Use of Apple Logo To Bw Banned in Beijing (August 7 Reuters)

Everyone who owns Apple or other equities are waking up today and wondering what to do. We are clearly in unprecedented territory with S&P downgrading U.S. debt but it is important to keep things in perspective and not overreact. The Wall Street Journal has an excellent recap of the week that was and presents alternate ways to play the market going forward. If you are a long term investor who can stomach volatility then you have an unbelievable opportunity with Apple. As I predicted last week, Apple would “get dragged down in the intermediate term with the rest of the market” so use this as an opportunity to accumulate Apple at a discount and write calls against your holdings. Remember that Steve Jobs will likely announce the iPhone 5 later this month, acting as the catalyst that propels Apple to a new high. As you can see from the list of links above, this was a relatively quiet week for Apple and it was primarily macro level issues that drove Apple down by over 6%.

Below I present three possible scenarios and the potential returns for the August 12 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.

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AAPL 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.

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AAPL Sensitivity AnalysisClick to enlarge

With this information, executing a buy-write on AAPL August 12 (Weekly) 380s is the optimal risk-return strategy. If you are uncomfortable with this approach, I suggest utilizing the 375s or 385s. I cannot stress enough that you need to be conservative in this environment and generate income but do not get greedy in the short-term. An alternative approach is to sell out-of-the-money 370 puts and collect the premium without having to purchase the stock outright, but even this is quite risky now. Note that if the stock declines to the strike price, you are obligated to buy the stock (or closeout the position). In the past I have recommended a short straddle but that would be imprudent with a potential market-wide correction.

Disclosure: Author is long AAPL; plans to write August 12 385 Calls.