Sunday, January 7, 2007

Is There Another Way to Buy AAPL?

With the Consumer Electronic Show (CES) going on this week in Lost Wages-I mean-Las Vegas, all attention is being paid to Apple (Nasdaq: AAPL). All gadget geeks are awaiting the much anticipated iTV and iPhone (see Apple Expected to Launch New Product).

What does this mean to directional bullish option traders? To some it may mean be a buyer of call options or a seller of put options. Now which one should we choose.

Well here's what I'm considering (doesn't mean that you should): Being a bullish credit seller. What the heck does that mean? It means that you can either be a naked seller of puts or you can be a credit spread put seller. They are both bullish plays. But which one is better or less risky?

Here's the skinny: If you are long term bullish on AAPL then, yes, you could indeed buy call options either ITM, ATM, or OTM. It's your choice. But (here comes the big "but" not "butt") the problem is the current Implied Volatility levels of AAPL options especially on the front month Jan 07 calls and puts.

If you like just receiving premium and possibly owning the stock (assuming you have sufficient buying power), then you probably don't and won't mind getting assigned the stock by a put buyer who exercises his/her right to sell AAPL stock if the put option remains ITM (I hope that makes sense to some out there).

Right now, the JAN 07 85s and 80 puts have IV levels in the low 60% levels. So what? Well these are at 52 wk high levels which means that the anticipation of new product intros at the CES have been factored into the option premiums.

I'm still lost, you say. What I'm saying is that once any major announcement concerning Apple's new products or any non-announcement (not likely but probable) will most likely cause a sudden drop in IV which, correspondingly, will or could cause a drop in premium values.

The only way to offset this drop in IV in the premiums is if the underlying stock price moves higher quickly. So if you want to be a longer term call buyer of AAPL then it might make sense to wait until the IV levels regress to the "mean" of annual IV levels.

You might say, "well is there anything we can do to take advantage of this possible IV drop?". And I respond, "yes, indeed. Sell option premium, specifically put premium."

Here's what I'm looking at: Enter a ATM/Slightly ITM Bull Put Credit Spread position. That entails selling the JAN 07 90 puts currently selling for $6.80 (as of 1/5/07 closing price) and simultaneously buying the JAN 07 85 puts currently asking $3.90.

That would give you a net credit of $2.90. That basically means that if AAPL's stock price trades above 90 by January's expiration Friday which is in 12 days from today 1/19/07, one will get to retain the full net credit of $2.90/contract.

The maximum risk of this trade is the difference between the strikes (90/85) and the net credit (2.90) which would be $2.10 in this example (5-2.90). It's not the greatest reward-to-risk ratio but it nevertheless is better than most credit spread r/r ratios (take it from me, I've seen a lot of them).

Now does one have to wait until expiration to achieve full profit? Absolutely not. At any point if the stock makes a move higher say up to $90 by this coming Friday or sooner (AAPL certainly does have fast moving potential), and the IV levels drop, you can buy back the JAN 07 90 Puts at a much lower price than the original sales price and leave the JAN 07 85 Puts alone to either expire worthless (saves you a commission), or, you could close both positions at any point with a smaller net debit amount than your original net credit amount (that's good by the way-sell high and buy low in reverse).

Then at any point after IV has considerably dropped and/or stabilized you can research possible longer term call options to buy.

Alright, I realize for some that might be a lot to swallow so feel free to get further clarification or make any comments by grabbing a vine on the Option Jungle.

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