Apple (Nasdaq: AAPL) continues to amaze.
After a sub-par earnings report roughly two-months ago the tech-behemoth has managed to tack on 22.9%.
Will it continue its advance? Maybe so, maybe not.
Does it matter? And can we truly answer such a question with a definitive answer anyway?
As an options trader and a self-directed investor I really don’t care. I only care about growing my portfolio through income generating strategies like the one I use in my Option Advantage service.
But let’s get back to Apple.
So, how can we take advantage of the recent price action in Apple?
Look no further than the bear call spread.
What is Bear Call Spread?
A bear call spread is a credit spread composed of a short call at a lower strike and a long call at a higher strike. The nature of call pricing structure tells us that the higher strike call we are buying will cost less than the money collected from the sale of a lower strike call. It is for this reason that this spread involves a cash inflow or credit to the trader/investor.
The ideal condition is for the spread to expire worthless, thus allowing you to keep the premium collected at the time of the sale of the spread. In order for this to happen, the underlying will have to close below the lower strike call option that you are short.
The basic premise of the strategy is easy: you choose the probability of the trade. Increasing the probability of success will decrease your potential profits, but will increase your likelihood of success.
So, with Apple recently surging to over $700 and into a very overbought state I think the stock is well overdue for a pullback, at least momentarily.
Again, now that I have an assumption in place, let’s move onto my strategy of choice…the bear call spread.
With Apple trading at $690, I want to choose a short strike for my bear call spread that meets my risk/return objectives.
I prefer to put a little more on the table to gain a higher probability of success, because ultimately you want a winning trade. Yes, I could bring more money in by selling a strike that is closer to the current price of Apple. But this lowers my probability of success. Don't forget, the ultimate goal is to increase your probability of success while at the same time taking on risk that allows for a return that is suitable for your income goals.
Again, this is how one important way that I trade in the Options Advantage portfolio.
I prefer a win rate/probability of success in the 70%-95% range. As such, I like the Oct12 750/755 bear call spread.
I like to give myself a decent margin for error, which obviously increases my probability of success. For example, the 750 strike allows for a $50 or 7.1% cushion to the upside.
As it stands, the Oct12 AAPL 750/755 bear call spread can bring in a credit of approximately $.62 or $62 per contract.
As a result:
- The max gain on the trade – 14.4%
- Probability of success – 86.6%
Apple would have to move above $750.62 for the trade to start losing value. As long as the stock price stays below $750.62 through October options expiration the trade is successful.
Credit spreads are my favorite way to trade options, particularly selling verticals. It's an extremely simple strategy to learn and arguably the most powerful strategy in the professional options traders' tool belt.
As always, if you have questions, feel free to drop me a line at [email protected].
Editor and Chief Options Strategist
Options Advantage and The Strike Price