Apple Weekly Bull Put Spread

May. 7.12 | About: Apple Inc. (AAPL)

Last week, Apple stock had a 20+ point downward move. On Monday April 30th, Apple opened at $587.32 and on Friday, May 4th it closed at $565.25, a $22.07 drop.

Mean reversion is a characteristic of asset price movement. What it means is that stock prices will have a tendency to revert towards the mean after a big move. If you look at the chart of Apple below on April 24th, Apple closed at $560.28 and after the earnings announcement; it opened on April 25th at $615.64, a move of 3.99 standard deviations. The red bars at the bottom of the daily chart below show the price moves measured in standard deviations. Following a big move, some mean reversion can be expected. Now that Apple has declined, a move back to the upside may be anticipated. The daily chart of Apple below, in addition to showing the standard deviation bars on the bottom has Bollinger Bands illustrated. The upper band is at $639.84, the lower band is at $553.09 and the midline, which is the 20 day moving average is at $596.47. If you have the opinion that Apple will move up from Friday's close towards the 20 day moving average, one way to play that move would be with a bull put spread.

A bull put spread is a credit spread, which means that we'll receive an initial credit for establishing the position. We'll sell a higher strike price put and purchase a lower strike price put for insurance. If we use the weekly options that expire on May 11th, we could sell the $565 put for $8.15 and buy the $560 put for $6.25 for a net credit of $1.90. If you set your maximum allowable loss at $5,000, you would use a 16 contract spread. With 16 contracts the actual maximum loss would be $4,960. The maximum gain would be $3,040, which is the initial credit times the number of contracts. The expected profit on this spread is $3,040. Remember to always calculate the expected return on any option trade and avoid trades that have a negative expectancy. This spread will have net delta of 143 and a theta of 32. Positive delta means that we are bullish. It is equivalent to being long 143 shares of stock. The theta means that we will earn $32 per day just from option decay. The implied volatility of these options is about 27%. The breakeven at expiration is the short strike minus the initial credit, which is $565-$1.90=$563.10. If Apple moves below that you'll want to cut your losses or make adjustments by buying more puts, selling calls or shorting some shares.

(click to enlarge)Apple with Bollinger Bands and Standard DeviationsClick to enlarge

(click to enlarge)Profit and Loss GraphClick to enlarge

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.