After hitting a split-adjusted all-time high in the last few trading days of November at $119.75, Apple Inc (AAPL) dropped slightly more than 6% during the balance of 2014 and into the near year.
The decline along with the broader market has pushed implied volatility on Apple stock to a 52-week high. This upward move in premium cost presents an attractive opportunity for all Apple investors to benefit by trading options strategies.
Implied volatility is the market’s estimate of how quickly a stock price will move in the future. Higher relative premium costs for call and put options are driven by increases in implied volatility. And implied volatility on Apple stock is currently trading at 52-week highs.
Covered Call Strategy
A relatively simple option strategy is a covered call, which entails purchasing Apple stock and simultaneously selling a call option contract on the stock. Each option contract is 100 shares, so for this strategy you would need to purchase a least 100 shares of the stock. The benefit of a covered call strategy is it allows you to benefit if the price of the stock rises, but also protects you if the price of the stock falls.
By selling a call option, you are taking advantage of higher premium costs currently associated with Apple call and put options. The recent volatility in the broader stock market combined with the beginning of the earnings season has created an advantageous period for those looking to sell options.
Obviously, the price of both the stock and the option will continue to change, and with this in mind, the strike prices that I recommend will also change, but the concept of selling a covered call should stay in place while implied volatility remains near its 52-week highs.
If you are very bullish on the price of the stock, sell an out-of-the-money option which provides the largest upside. For example, you could purchase the stock around $112, and simultaneously sell a February 2015 $120 strike call for $1.90 which would give you a little less than 2% of downside protection. If the price of the stock rises above $120, your shares will be called, generating a profit of $9.90 per share ($120-$112 + a premium of $1.90). If the price of AAPL falls, your breakeven price is $110.10.
Vertical Spreads
There are two types of vertical spreads: call spreads and puts spreads. A call spread is a strategy where you simultaneously purchase a call and sell a call that have different strike prices, but expire on the same day. A put spread has the same construct, but you are trading puts.
When implied volatility is high like it is with Apple stock, you can benefit by selling call spreads and put spreads. If you are bullish about the price of the stock, you would sell a bullish put spread, and if you are bearish the price of the stock you would sell a bearish call spread.
With Apple earnings scheduled for the January 27, I recommend selling call spreads and put spreads that have option expiration dates that occur prior to this date.
For those who believe the price will rise, I recommend selling an AAPL JAN 23 $109-$106 puts spread (which expires on January 23), where you sell the $106 strike put and purchase the $103 strike put for 60 cents. The most you can lose is $3 on the trade and the most you can gain is 60 cents. The option expires in approximately two weeks, and based on the historical movements of Apple stock, both options have approximately a 75% chance of settling out of the money, allowing you to keep your 60-cent net premium.
One added benefit to this trade is that the price of Apple can actually fall down to $108.40 and you will still break even on the trade.
For those who believe that price will fall, I recommend selling an AAPL JAN 23 $116-$119 Call Spread for 50 cents. In this trade the most you will lose is $3 per share and the most you can gain is 50 cents. This option expires on the 23rd of January, and based on historical movements in the stock price both options have approximately a 72% chance of settling out of the money allowing you to keep your 50-cent premium. On this trade, the price would need to move above $116.50 for you to lose money.
The exit strategy is to wait for your call spread or put spread to expire out of the money, but you can easily buy back either your call spread or put spread prior to expiration.
Regardless of whether you use a covered call strategy or a vertical spread strategy to reflect your bias on Apple stock, elevated levels of implied volatility are likely to generate opportunities for you to take advantage rich premium levels and generate profitable option trades.
As of this writing, David Becker did not hold a position in any of the aforementioned securities.
