Apple (NASDAQ:AAPL) is a unique company due its size ($355B), 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.
A brief recap of the past week in Apple (down $18.54 or -4.6%):
- Conflicting JPMorgan iPad Reports Shake Apple (September 27, Bloomberg)
- Apple: Lets Talk iPhone (September 27, The Loop)
- Amazon (NASDAQ:AMZN) Announces Kindle Fire Color eReader (September 28, Bloomberg)
- Google To Announce Nexus Prime October 11 (September 28, TechCrunch)
- Nokia (NYSE:NOK) To Lay Off Another 3,500 Employees (September 29, Forbes)
- JPMorgan: Kindle Fire is “Noise” (September 29, Apple Insider)
- Schwartz: “Most Revolutionary User Interface in the History of Technology” (September 29, Seeking Alpha)
- iPhone Users Love Their iPhones (September 30, New York Times)
- Amazon Rumored To Be Interested in HP’s (HPQ) webOS (September 30, Apple Insider)
Are you ready for the iPhone 5? In another difficult week for the market, Apple declined nearly $20 and reached multi-week lows. Unlike previous weeks, Apple did not fall strictly for macroeconomic reasons, as there was significant Apple-related news that punished the company. But was the news really that bad, and did Apple deserve to get punished to the tune of 4.6% mere days before the new iPhone launch? I will explain why the answers are a resounding no.
The selloff began in force when Hong Kong-based JPMorgan analyst Gokul Hariharan reported that Apple was cutting iPad orders by twenty five percent; however, this report was largely discredited by US analysts. Apple was able to rally through this pessimism but resumed its downward decline after Amazon announced its Kindle Fire, considered by many to be a competitor to the iPad. In fact, the Kindle serves an entirely different market. Consumers are not deciding between a Kindle and an iPad but are rather choosing between a Kindle and Barnes & Noble’s (NYSE:BKS) Nook Color. Taken in conjunction with the threatened competition from Google’s (NASDAQ:GOOG) new Nexus Prime, Apple investors were likely worried. Apple has so much momentum at this point that the even a direct competitor in the tablet or phone space would have difficulty gaining traction. After accounting for the fact that neither the Kindle Fire nor Nexus Prime has the well-developed ecosystem Apple has, Apple investors can sleep well at night.
Despite declining so significantly this week there are still tremendous opportunities available for option investors. Whenever Apple is about to announce a new product, the time value surges as investors like to bullishly speculate, and you can take advantage of that optimism. Whether you are conservative or willing to take risks, there are option strategies outlined for you below.
Below I present three possible scenarios and the potential returns for the October 2 weekly options (Source: TD Ameritrade). The first scenario represents a negative outlook for Apple, while the final two scenarios are more reasonable. These scenarios are just projections, and there is no guarantee they will come to fruition. 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 (click tables to enlarge).
With this information, executing a buy-write on AAPL October 2 (Weekly) 385s is the optimal risk-return strategy. If you are uncomfortable with this strategy I suggest an ordinary buy-write 380s or 390s. The 380s have the greatest time value ratio (3.2%) but I want to maintain the opportunity for stock appreciation with the 385s (2.8%). Even if you are extremely bullish you can still profitably sell covered calls. If Apple simply returns to its 50-day SMA of $397.46 you can bag a 5.2% return which annualizes to a jaw-dropping 380%. An alternative approach is to sell out-of-the-money 380 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 close out the position.
Disclosure: I am long AAPL and GOOG; short AAPL October 22 415 Calls.