Bookmark and Share Weekly Apple (AAPL) Trade April 24

Yesterday Apple announced earnings, a new stock buyback, and a dividend increase. Sadly, they also announced there would be no new products until fall. The stock is, therefore, likely to trend sideways for several months. While this is bad news for AAPL shareholders with a cost basis above the current $405, a sideways trending stock is the perfect candidate for covered call investing.

First, we are going to look at a new trade using AAPL weeklys. Then we will address the repair strategies for people already in AAPL at a higher cost basis.

New AAPL Weekly Trade

Because we believe AAPL will trend sideways to slightly up between now and new product announcements in the fall, we are suggesting buying AAPL and writing a slightly in the money weekly call. The ex-div date for the $3.05 dividend is May 9, so we will look at the May 10 weeklys. You will get the call premium plus the dividend:

Expiration Strike Call Bid Net Debit
(incl dividend)
If Called
Annualized Return
(17 day trade)
May 10 395 17.55 387.26 7.74 114%

With the ex-div date so close to the option expiration date (1 day apart), there is a risk of early exercise. However, for that to make economic sense to the option holder, there would need to be zero time premium remaining in the option. It is unlikely that there will be zero time premium in an AAPL option with 1 day remaining, unless AAPL is significantly in the money at that time. But, even if called away with an early exercise, you will still make money with the above trade.

Repair Existing AAPL Weekly Trade

Last December we initiated an AAPL covered call trade that is still open. After having 8 sets of weekly covered calls expire out of the money on that trade, our cost basis is now 468.52 or 483.54 (depending if you started with one of 2 strikes that were offered as reasonable starting points). With AAPL at $405 right now, we are 63 to 78 points underwater on that trade. Let's see how we might repair it.

1. Do nothing and wait. Those who wait will receive a $3.05 dividend every quater while they wait. Assuming the stock rises 10-15% between now and the new product launch in the fall, you could break even on the trade within 6 months.

2. Write an August 455 strike covered call for 8.85. You will receive 2 dividends for 6.10. Earnings come out July 23. You will have lowered your basis by about 15 points. If called away at 455 then the investors with a current 468.52 basis (lowered to 453.57 from 2 dividends and 1 call) will be out of the trade with a small profit. Those with the 483.54 basis will still have a loss.

3. Buy more AAPL to average down your cost, then sell calls with strikes above the new lower average basis. For example, if your basis is 468 and you buy the same number of shares at 405 then your new average basis is 436.50. You could sell 435 strike calls and come out of the trade with a gain if called. The June 435s are bid at 7.00 right now, for example.

4. Zero-cost ratio spread. This is a little tricky but lowers your cost and increases your odds of breaking even. It has the downside that the best you can do is break even. Assuming you have 100 shares of AAPL, you would buy 1 June call with a strike of 405, and sell 2 June calls with a strike of 435. The 405 will cost you 17.30 and you will receive 7.00 for the two 435s. Your net debit is 17.30 - 14.00 = 3.30, which is roughly the same as the dividend you will get on May 9 (3.05), so pretty much a zero cost trade.

If AAPL closes at 435 on Jun 21 then the 2 options you shorted expire worthless, while the one option you purchased can be sold for 30 (since it's 30 points in the money). You can use those 30 points to lower your basis from 468 to 438. With the stock now at 435 you can sell it and get out for a small loss (3 points).

If AAPL is above 435 on Jun 21 then the 2 options you shorted will be exercised but since both are covered (one by the stock and one by the call you bought) the math works out the same as if the stock closed exactly at 435.

If, on the other hand, AAPL is below 435 on Jun 21 then you can sell the call (assuming it's in the money, i.e. AAPL is above 405) and lower your basis by that amount; and then repeat the process for some future option cycle.

5. Sell slightly out of the money weekly calls each week, and be prepared to buy them back if AAPL rises. You can probably get 5-6 points per week in time premium by writing the nearest out of the money weekly option. If AAPL should finish in the money then you would buy back the weekly option and sell another one for the following week.

There is a risk that by writing a below-basis strike price you will miss out on any sudden gains the stock has above the strike you write. But, given the recent announcements from AAPL we believe the odds of a sudden spike up are unlikely in the next few weeks. For the current week, with AAPL at 405, we would sell the May 3 expiration with a 410 or 415 strike. By managing the trade this way, you should be able to lower your basis by 5 points per week.

There is another choice, of course, which is to sell your AAPL shares and move on to some other opportunity, but we believe AAPL still represents a good covered call candidate with long term potential.

Mike Scanlin is the founder of Born To Sell and has been writing covered calls for a long time.

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