If you love cars like I do, you know that the auto industry keeps a tight lid on the details, including images, of cars set to be released in the future.
But Motor Trend, an automobile magazine that features the latest and greatest in car news, got the jump on Apple, tweeting out the first so-called image of Apple’s “secret” electric car that’s rumored to be released as early as 2019 or 2020.
Apple, of course, will not comment, neither confirming nor denying the existence of its electric car initiative, called “Project Titan.” But its efforts to keep its plans classified haven’t quite succeeded… making the possibility of an Apple car more of an “open secret” within the automotive and technology industries.
Now skeptics say there’s no room for newcomer, Apple, to rival the likes of Tesla when it comes to electric cars (or cars in general) while optimists say Apple could revolutionize the auto industry, boasting of the historical milestones it’s already made in the technology industry.
No matter who ends up being right, Apple’s “secret” is out, making it the prime time to capitalize on huge gains opportunities.
In fact, the day that this news “leaked,” the stock climbed to $112.10 per share… up from Tuesday’s close of $110.44 and Monday’s close of $109.02.
And I’m going to show you just how you can profit right now…
How to Play the Apple “Leak” Using Long-term AnticiPation Securities (LEAPS)
On Wednesday, we talked about LEAPS (options with longer expiration dates of up to threeyears) and how trading them is a great alternative to shorter term options and buying the stock outright.
And the recent Apple “leak” is the perfect opportunity to look at two LEAPS trading set-ups that could set you up for triple-digit gains by the time the Apple car is released.
What we’re going to do is look at a hypothetical scenario in which two traders take a bullish position on Apple Inc. (NASDAQ: AAPL) but have two very different LEAPS trading ideas. We’re also going to look at the risks and benefits of each, which can help you determine the type of LEAPS trader you might be and the trading strategy that might suit you best.
Let’s get started…
The Scenario
After learning of the Apple car “leak” and seeing the way the stock reacted, traders Abe and Bea both see AAPL going to $140 per share – or higher- but believe it will take some time to get there… possibly up to two years.
They also both believe in leveraging the power of options to reduce the cost to participate in this movement, as they don’t want to pay $112.10 per each share of stock they’d like to control. They decide to trade LEAPS because they know that LEAPS options are even cheaper than standard options.
But here’s where Abe and Bea differ…
Abe is a get-more-bang-for-your-buck kind of trader who has a set goal of profitability over probability when it comes to his trades. He knows that his percentage for successful trades decreases with this trading mindset, but he believes that the ultimate payoff is worth the risk.
Bea, on the other hand, is more interested in a return OF her money than a return ON her money. As a more conservative trader than Abe, she prefers trading based on a higher probability of successful trades over merely a higher profit. Unlike Abe, she is happy with taking on a less-risk-less-reward strategy.
Here’s how they decide to play the Apple “leak…”
The LEAPS Trade Set-Ups
Abe decides to simply buy to open call options. He chooses the AAPL January 19, 2018 $120 Calls, which are currently trading at $10.93 per contract.
Bea decides to go with a debit call spread (or bull call spread). She opts for the AAPL January 19, 2018
$120/$140 vertical call spread for $5.50 per contract.
The Costs of Each Set-Up
Abe is a long LEAPS option trader who bought-to- open one contract of the AAPL January 19, 2018 $120 Calls. The cost of one contract (100 shares of stock) multiplied by the option’s premium of $10.93 brings his total cost, excluding fees and commissions, is $1,093 ($10.93 * 100 shares).
Bea is a bull call spread LEAPS option trader who bought-to-open the AAPL January 19, 2018 $120 calls and sold-to-open the AAPL January 19, 2018 $140 calls, creating a bull call spread. She bought-to-open the $120 calls at $10.93 and, on the same order ticket, sold-to-open the $140 calls at $5.43. Her total cost, excluding fees and commissions, is $550 ($10.93-$5.93 = $5.50 * 100 shares).
Just as Bea wanted, the cost of her trade was less than Abe’s, who spent nearly twice as much on his trade.
The Risks of Each Set-Up
As a LEAPS traders, Abe’s and Bea’s maximum risk is 100% of their costs to open the trade. Since Abe spent $543 more than Bea on his trade, his long LEAPS calls trade has more risk than Bea’s LEAPS bull call spread.
*(When it comes to your trades, keep in mind that you can place a stop wherever you like and can minimize your risk by creating a LEAPS call spread, just as Bea did)*
The Profit Potential/Return on Investment of Each Set-Up
With calls, when the stock price goes up, so should the option’s value. Now Abe took on greater risk for greater reward potential and has technically an unlimited reward potential (up to the close of market on the date of expiration).
For example, say that AAPL skyrockets to $200. The option at that time is going to be in-the-money by at least 60 points, which means the premium will have at least $60 of intrinsic value priced into it. If AAPL goes to $200, then the option will have at least $60 in intrinsic (or real) value in the premium. One contract at $60 equals $6,000. Once Abe subtracts the original cost of $1,093, he’s left with a very nice profit of $4,907.
Consider it this way… For every $10 in-the-money move AAPL makes, Abe gets $1,000 potential increase in the value of the option.
Now if the stock goes to $140.10 and takes until the option’s expiration, there could be no value left in the premium, which would result in a 100% loss. The stock could also go to $200, and the premium could have a value of $8,000 at expiration. If you offset this with the original cost of $1,093, his total return on investment is $6,907 … or 631%.
But Bea, who prefers smaller risk and smaller reward,does not quite have that unlimited reward potential…
Her maximum profit is capped due to the nature of the call spread. No matter how high in price AAPL goes beyond the $140 calls, her maximum profit is $1,450.
How?
When the stock goes over $140, the market can buy her stock for $140 (the price of the calls she sold-to-open). But since Bea does not own the stock, she would have to buy it at $120 (the price of the calls she bought-to-open). And since this is a spread, both transactions should be placed at the same time. This means the account should reflect a credit of $20 ($140 calls – $120 calls= $20 profit) offset by the debit incurred open the trade of $5.50. The end result is a profit of $14.50 ($20 -$5.50 = $14.50), which is a total of $1,450 profit ($14.50 * 100 shares).
Bea just needs to the stock to be in-the-money at expiration for the spread to execute and bring in the $1,450. So her total return on investment is $1,450 … or 263%.
In Conclusion…
Depending on how AAPL moves, Abe has the possibility of banking a great return on investment… or none at all. Ultimately, the stock has to work harder and go higher for greater profit potential.
Since Bea opened a call spread, she only needs AAPL to move slightly above the $140 strike price of the calls she sold-to-open to realize her maximum profit potential. With a spread, LEAPS or not, the stock doesn’t need to work as hard to offer at least a 100% return on investment or better.
When it comes to you… the type of LEAPS trade set-up you want to use ultimately depends on the type of LEAPS trader you are and the risk you’re willing to take.
On the one hand, you can aim for a higher payoff, which requires more risk… like Abe.
On the other hand, you can aim for less risk, which offers less reward… like Bea.
Do you want a higher potential payoff which requires a higher amount of risk / less probability? Or do you want less risk which makes less reward potential but you get that higher probability for success.
Only you can decide, but the trade scenarios above can help you determine the best way to play the Apple “leak.”
Here’s Your Trading Lesson Summary:
LEAPS offer traders the extra time to capitalize on upward or downward stock movements. But there’s more than one way to set up LEAPS trades. Here are LEAPS trade ideas for an upward movement:
- Buy call options for more risk but greater reward potential
- Create a bull call spread for less risk but smaller reward potential
Good Trading,
Tom Gentile
