Go Long Apple Before Record Earnings

| About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) was co-founded by the late visionary Steven Paul Jobs and has completely transformed every industry it operates in. The focus on innovation has made Apple one of the largest and best performing companies in the world. 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. As we enter the post-Jobs era, it is even more important to keep a close eye on your investment and execute care with your trades: Since Jobs has passed the company's performance will be under a magnifying glass.

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A brief recap of this week in Apple (up $13.00 (3.2%)):

  • Apple and Google Rumored to Bid on English Premier League Rights (January 4 Daily Mail)
  • Rumors of March iPad 3 Pickup Steam (January 6 Apple Insider)
  • China Unicom CHU Promoting Free iPhone 4S With Contract (January 6 Bloomberg)
  • Apple To Open Mini-Apple Stores in Target TGT (January 6 Apple Insider)

Are you ready for Apple's breakout ahead of earnings? After a sleepy last week of 2011, Apple burst out of the gates in 2012 to log a $13 weekly gain and this looks like it will be another banner year for Apple. We all know about the normal product lines that will drive Apple higher such as the iPad 3 and iPhone 5, but the way in which Apple executes on the little things is what separates it from peers. The Target and English Premier League news are examples of how Apple is always looking for opportunities to expand its empire, make its products more attractive, and make it easier for customers to purchase its goods.

The pattern of Apple bottoming-out between quarterly earnings and rapidly rising before next quarter's earnings has repeated once again. I receive lots of messages asking about selling calls before earnings and the answer is not always straightforward. Even if you think Apple will climb after earnings there is nothing wrong with hedging your investment by selling covered calls on a portion of your investment to mitigate any potential losses. Due to the fact that investors are extremely optimistic about earnings, the prices of call options get bid up rapidly and as a covered call seller you can take advantage of that exuberance.

Four Ways To Play It:

1. Go long Apple and be optimistic about its upcoming earnings

2. Go long Apple and sell weekly/monthly covered calls (for details see the end of this article)

3. Write weekly/monthly cash-secured puts that are approximately 5% out-of-the-money

4. Buy AAPL Mar 2012 430 calls as a leveraged way to gain exposure to Apple

All signs still point to an updated iPad in the first quarter of 2012 and a revolutionary iPhone 5 in the summer/fall. These catalysts alone should drive Apple to new heights. But the perpetual talk of iTV and a potential redesign of the MacBook Pros will be gravy.

Below I present three possible scenarios and the potential returns for the Apple options. 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 that they will come to fruition. Even if you are optimistic it is important to generate both positive and negative circumstances in order to stress your assumptions. 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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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 at the end of the week. Estimate where you believe Apple will close and select the strike price with the highest return.

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With this information, executing a buy-write on AAPL January 13 (Weekly) 430s is the optimal risk-return strategy. If you are uncomfortable with this strategy I suggest a buy-write 420s, 425s, or 435s. Even if you are extremely bullish you can still profitably sell covered calls. Apple is volatile enough that you will have opportunities to repurchase on dips. An alternative approach is to sell out-of-the-money 420 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 close out the position).

Disclosure: I am long AAPL.