Use Options To Go Long Apple Earnings And Earn 43% Return With Controlled Risk

| About: Apple Inc. (AAPL)

On Monday, Apple (AAPL) announced that earnings will be released after market close on July 24, 2012. I, and it seems everyone else, am bullish on Apple. In fact, based on Apple's current price-to-earnings ratio of 14.44 and earnings estimates of $54.23 EPS for the next year, we may be able to expect a price of $783 a share. In this article, I will not be attempting to convince you to buy Apple but rather will explore an efficient way to get long exposure to the stock.

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If structured correctly, options can help you manage risk while still profiting off Apple's earnings. The appeal of this trade is that in order earn our maximum profit, Apple does not even need to blow out earnings and go parabolic; we just need the stock to not crash.

Buy Aug 570 Call ($40.70)
Sell Aug 580 Call $33.70
Net Debit to Initiate ($7.00)
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This option position is called a bull call spread. In this trade we buy a lower strike call, 570, and sell the higher strike 580 call. By both buying and selling calls, we have a hedged position with limited risk and limited reward. Because we have a full range of strike prices to choose from, we can tailor our risk/reward to our exact liking.

  • Max Profit: AAPL > 580: $3.00 profit
  • Break even: AAPL = 577.00
  • Max Loss: AAPL < 570: $7.00 loss

The strength of this trade is that with Apple's current price of 596.96, we have downside cushion of 3.34% in which we still earn our max profit. Our maximum profit is made as long as the stock closes above 580 on expiration day in August. This gives us three favorable scenarios: Apple rises, stays unchanged, or drops less than 3.34%. In this respect, we have created high odds for a profitable trade.

With the stock above 580 at expiration, the long 570 call will be worth $10 more than the short 580 call, resulting in a ($10 - $7.00) = $3.00 profit or a 42.8% return in seven weeks. We also have the flexibility of closing the trade before expiration day. In this case, we have likely reduced profit, but will also have limited risk.

The break even point on this trade is 577.00 and maximum loss will be incurred below 570 with the loss limited to the cost of initiating the position, $7.00.

Disclosure: I am long AAPL.