A Different Way to Take a Bite out of Apple

by Tyler Craig | February 15, 2012 7:48 am

As Apple (NASDAQ:AAPL[1]) continues its pursuit of tech-world dominance, its rising share price continues to gobble up every short-seller in its path.  With this week’s breach of $500, the bulls were beating their chests like a bunch of banana-drunken baboons.  And, hey, who can blame them?

Concurrent with the stock’s meteoric rise, we’ve seen a mad dash into the derivatives market as speculators have snatched up out-of-the-money call options set to expire at the end of the week.  This surge in demand has driven implied volatility much higher, increasing the relative expensiveness of these potential lotto tickets. The result is a somewhat rare occurrence referred to as an “upside volatility skew.”

The emergence of such a skew presents some interesting “options” for those looking to take a profitable bite out of AAPL.  Call ratio spreads in particular look ripe for the picking.

The call ratio spread consists of buying a lower-strike call option while selling multiple higher-strike call options in the same expiration month. (In other words, you sell more options than you buy.)

The profit zone peaks at the higher strike price, making it the ideal resting place for the shares at expiration.  In the event the stock rises too much, however, the trade can start to accumulate losses.

Traders looking for AAPL to continue its rise into February expiration this Friday should consider “buying to open” one February 515 call while “selling to open” two February 525 calls.  Currently the spread can be initiated for a net debit around 80 cents.

As shown in the risk graph below, the downside risk is limited to the initial $80 (80 cents x 100) paid at trade inception, and the max reward is north of $750 if AAPL pins right at $525 at expiration.

This trade takes advantage of volatility skew by buying options with a low implied volatility (IV) — the Feb 515 call has an IV of 34% — and selling options with a high implied volatility — the Feb 525 call has an IV of 38%.

The upside risk in a trade like this can be substantial if the rise in AAPL gets out of hand. Traders should have a game plan to exit quickly if the stock surges much past $525 or $530 in the coming days.


Source:  MachTrader

At the time of this writing Tyler Craig had no positions on AAPL.

  1. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL
  2. [Image]: https://investorplace.com/wp-content/uploads/2012/02/AAPL-Ratio-Spread.jpg

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