Apple Set To Open Cash Coffers: Potential Options

| About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) is the largest publicly traded company in the world and has completely transformed every industry it operates in. Steve Jobs' focus on innovation has permeated the company and created a commitment to consumers that has handsomely rewarded shareholders throughout the years. I have recommended option strategies for Apple since 2010 with tremendous results (remember past results do not guarantee future results).

For reference, please view the first and other articles in the series to fully understand the strategy and its strong potential returns. In essence the investment objective is to capitalize on Apple's volatility by selling out-of-the-money options to generate weekly income without sacrificing long-term returns.

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A brief recap of this week in Apple [Up $36.59 (6.7%)]:

Apple is hosting a conference call at 6AM eastern to "announce the outcome of the company's discussions concerning its cash balance." The stock will be likely see record volume and will require you to adjust your option strategies accordingly.

Apple's $37 dollar surge was the largest appreciation for the company and the second highest percentage appreciation of the year. The market capitalization now sits above $545 billion and analysts have targets sitting in the $700 billion market cap range. Apple obliterated its previous all-time high as it surged to $600 on Thursday before settling around $585 for the remainder of the week. Stocks never appreciate in straight lines but it is foolish to fight the momentum that Apple has right now.

The early part of this week should have news detailing the initial success of the iPad and I personally expect sales to come in around 1.5 million, only due to shortages of the device and the difficult to manufacture screen. With this in mind, it would be prudent to take profits on some of your position near $600 especially if you are a new Apple shareholder sitting on near 50% gains from 2012 alone. As I write weekly, there are an abundance of ways to lock-in profits that I detail below in the sensitivity analysis. Here is a simplified playbook for trading Apple this week:

  • Cautious Investor (Apple below $585): Sell $585 covered call
  • Bullish Investor (Apple between $585-$605): Sell $600 covered call
  • Gambler (Apple between $605+): Consider buying out-of-the-money "homerun" option

As investor confidence in Apple increases, so do the option premiums and covered call writers can benefit from this optimism. The time value ratio for the 585s is 2.3% while the 590s hold an above-average 2.0%. The out-of-the-money options also have tremendous value this week as the 595s and 600s are $9.75 and $8.10, respectively. I will continue to bet on selling the out-of-the-money options and pick up approximately $10 per option on both good and weeks for Apple.

The overwhelmingly positive iPad news dominated the headlines this week but Motorola (NYSE:MMI) had key legal battles reaffirmed against Apple. The German injunction has relatively minor financial implications for Apple but the ITC loss could weaken Apple's position against Google's (NASDAQ:GOOG) Android. These lawsuits can move back and forth with dizzying frequency and will likely linger for years but are important to monitor for significant developments. Personally, I think Apple's lead in the tablet space is insurmountable due to the well-established ecosystem but Google is still a formidable foe that cannot be overlooked.

Investors need to be vigilant and monitor the new products and developments from all competitors. Remember what Tim Cook said at the new iPad announcement and smile as an Apple shareholder: "Only Apple could deliver this kind of innovation in such a beautiful, integrated and easy to use way. It's what we stand for," he said of the new iPad. "And across the year, you're going to see a lot more of this kind of innovation. We are just getting started."

In closing, there has been a lot of controversy surrounding Apple and its treatment of suppliers, notably Mike Daisey's "reports" from his trip to Apple factories. This American Life tracked down Daisey's translator and did additional fact checking which essentially refutes the vast majority of his "reports". Daisey has been one of the most critical pundits against Apple and it turns out that much of his allegations were fabricated. I do not want to draw any more attention to his false claims but this is just a reminder that Apple is a high profile corporate target and you need to take all Apple news with a grain of sale, even if the source is reputable.

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.

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.

With this information, executing a buy-write on AAPL March 23 (Monthly) 610s is the optimal risk-return strategy. I would refrain from writing any options on Monday as the stock will be extremely volatile with the Monday morning announcement. Please consult with your accountant or personal financial planner. If you are uncomfortable with this strategy I suggest a buy-write in the range of 585-615s.

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 585 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).

Disclosure: Author is long AAPL, GOOG, and MMI.

Disclosure: I am long AAPL, GOOG, MMI.