Options Tip Of The Week

This week I will share an options play that we are taking in advance of tomorrow’s earnings announcement by AAPL.  If you think it is a good idea, you will have to place the trade before the market closes Tuesday, January 24, 2012.

Options Tip Of The Week

Expectations are sky high for Apple.  The company reports earnings for the 4th quarter tomorrow, and Christmas sales are rumored to be through the roof.  People have reported long lines for a month at Apple retail stores.

Demand is so high for iPhones in China that hordes of country dwellers have been hired to take a train to a city to buy a single iPhone (payment $16 for a day’s “work”) but the stores don’t have enough products so many people were turned away.  A riot broke out and the stores were eventually closed (the website stills sells their products, but you wonder why they hire buyers if consumers can buy online).

It is always a good sign for a company when the biggest obstacle to success is making enough of the products rather than selling them.

On a fundamental basis, AAPL is trading at less than 11 times forward earnings, an extremely low number for a company growing at 39% a year (although it may be more than this amount – we will know tomorrow).

So will the stock skyrocket on Wednesday after the earnings announcement?  The answer is an unequivocal “maybe, maybe not”.  Expectations are so high that investors may be disappointed no matter what the numbers are.  The stock has gone up about $50 in the last month in advance of the announcement.   Maybe it will be another “buy on the rumor and sell on the news” event, and the stock falls in spite of the good news.

Terry’s Tips subscribers are already happy about our AAPL portfolio.  It has gained 136% since we started in April 2010, well more than double the increase in the price of the stock.

Here is the trade I am proposing to make right now (we did several similar to this last week in our AAPL portfolio).

Buy to Open 1 AAPL Feb-12 440 call (AAPL120218C440)
Sell to Open 1 AAPL Jan4-12 435 call (AAPL120127C435) for a debit of $1.05  (buying a diagonal) 

This trade will cost $105 (plus a commission of $2.50 at the rate paid by Terry’s Tips subscribes at thinkorswim).  There will also be a maintenance requirement of $500 because the strike price of the long side (440) is higher than the strike price of the short side (435).  The broker holds your cash aside to protect against the maximum possible loss you might incur.

When the Jan4-12 435 call expires next week, if the stock is trading below $435, you do not have to do anything.  That call will expire worthless, and you will be left with a long 440 call which has 3 remaining weeks of life.  No matter how low the stock might fall, it is unlikely that this call will be selling at less than $1.05 (your original cost).  In other words, if AAPL goes up as much as $10 from its current price of $125, or if it falls in value, the spread should make a profit.

If the stock is above $435, you will have to buy back the expiring call and sell the Feb-12 440 call at the same time.  It is uncertain what value of the option might be, but unless the stock goes up be an extremely high amount, the Feb-12 440 call should be worth at least $6.05 more than the expiring call so that you can still make a profit.

I hope if you try this little idea and you make a small gain, you will use it to come on board and start your option education for real.

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Any questions?   I would love to hear from you by email (terry@terrystips.com), or if you would like to talk to our guy Seth, give him a jingle at 800-803-4595 and either ask him your question(s) or give him your thoughts.

You can see every trade made in 8 actual option portfolios conducted at Terry’s Tips and learn all about the wonderful world of options by subscribing here.   Why wait any longer to make this important investment in yourself? 

I look forward to having you on board, and to prospering with you.

Terry