Profit From Apple’s Next Big Move With Less Than $500
Apple Inc. (Nasdaq: AAPL) has been one of the biggest stories of the year. And, heading into the end of the year, the story is likely to continue.
The company’s new products have been well received this year. Industry researchers at TrendForce estimate that Apple’s new iPhone production volume for this fourth quarter will reach 81 million units with iPhone X accounting for 33% of that.
And those iPhone sales are going to keep the smartphone market buoyant. In terms of total global production, TrendForce estimates a growth of 10.5% from the third quarter’s total – all thanks to the iPhone.
Financially, Apple has benefited significantly from its phones and services. The company reported revenue of $52.6 billion in the most recent quarter, which has historically been one of the weaker quarters in the year.
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This quarter, the company expects revenue to be between $84 and $87 billion as consumers line up to spend more than $1,000 on new phones and then pour additional money into warranties, apps and services.
The stock is now priced at about 15 times the current fiscal year’s expected earnings. Apple’s fiscal year ends in September. This is a below average price to earnings (P/E) ratio in the current market, making Apple a potentially attractive stock to value investors.
On the other hand, the stock’s average P/E ratio over the past five years has been 12. This is because Apple’s growth is relatively low, in percentage terms. Earnings growth is expected to average 12% a year in the next five years, and the P/E ratio reflects that level of growth
The Stock Reflects the Operational Success
Apple is now the largest publicly traded company in the world with a market capitalization of more than $900 billion. The stock is up more than 50% this year.
Investors have often been concerned about buying Apple. Its size presents one concern. Some investors question how fast a large company can grow and question whether or not Apple can continue delivering large gains in revenue and earnings.
The second concern, particularly for smaller investors, is the stock’s price. Apple is not the only company that presents this problem. It trades at a relatively high share price and that makes it difficult for small investors to gain exposure to the company.
An Options Strategy Brings the Price Within Reach
It is reasonable to expect a relatively large move in Apple. This is true because it is near the end of the year and many professional investors may want to show exposure to the stock in their portfolio. The stock could also make a big move if the stock market sells off.
This summarizes another problem of trading. It can be easier to forecast the fact that a move is likely in a stock than it can be to predict the direction of the move. Traders familiar with options may know the long iron butterfly strategy could help with this situation.
To profit from a large move, traders can use an iron butterfly strategy. The risks and potential rewards of this strategy are shown in the diagram below. The strategy profits from a large move in the stock but doesn’t require the trader to choose a direction for the move.
Source: The Options Industry Council
This strategy combines four options contracts. The trader will buy a call option and a put option with an exercise price that is close to the current price of the stock. The trader will then sell a call with an exercise price above the current price of the stock and also sell a put option with an exercise price below the current price of the stock.
All options will have the same expiration date. The options that are sold will have exercise prices that are an equal distance from the exercise price of the options that are bought.
Opening an Iron Butterfly in Apple
For Apple, the trade can be opened using the following four options contracts:
As you see, all of the options expire on the same day, Friday, December 15.
Selling the options will generate $4.15 in income ($2.10 from the call and $2.05 from the put). Buying the options will cost $8.20 ($4.20 for the call and $4 for the put). This means opening the trade will result in a debit of $4.05, or $405 for each contract since each contract covers 100 shares.
That is the maximum risk on the trade. This is generally true whenever an options strategy results in a debit, or the outflow of trading capital when opening a trade. For these strategies, the risk will generally be capped at the amount of capital used to open the trade.
Most brokers will require a margin deposit equal to the amount of risk. That means this trade may require just $405 in capital.
The maximum potential gain on the trade is equal to the following formula:
For this trade in Apple, the option with the highest exercise price is the $180 call. The middle exercise price is the $175 call and put. The difference between these two prices is equal to $5. Since each contract covers 100 shares of stock, this means the maximum risk on the trade is equal to $500 less the premium paid to open the trade.
The premium paid is equal to $405. Subtracting that from $500 we find the maximum potential gain on this trade is equal to $95.
The potential reward on the trade ($95) is 23% of the amount risked, a high potential return on investment for a trade that will be open for about a month. If a trade like this is entered every month, a small trader could quickly increase the amount of capital in their trading account.
Gains and Losses Compared to the Stock
This trade generates a gain if Apple moves at least 2.9% in the next month. On average, shares of Apple have moved 12% a month over the past 20 months. Over the past five months, that average has increased to about 14%.
Given the past history, this trade has a high probability of success.
Now, as an alternative, a trader could buy 2 shares of Apple with the amount of capital committed to this trade. Even if Apple has a large move of 20%, the potential gains for share holders are less than the potential gains from this strategy.
Owning shares also exposes an investor to larger risks. It seems to be unlikely, but shares of Apple could drop significantly. Losses tend to present traders with a different problem. Many want to believe the stock price will come back and they hold their positions.
In the end, they may be proven right and the stock could come back. But, they have committed capital to that stock that could be deployed elsewhere if they were not waiting for the stock to recover from a loss. This can be a mistake for smaller investors who need to take quick gains to compound their wealth.
The iron butterfly is an example of how options are a versatile tool and could meet many of your trading objectives. In this trade, options provide a low cost way to access a high priced stock.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.