This “Apple” Trade Could Make You a 70% Return in 7.5 Months

The momentous downslide in Apple (NASDAQ: AAPL) has halted with a possible double-bottom at the April $385 and June $388 lows.

[ad#Google Adsense 336×280-IA]With AAPL nearing $450 again, the upper end of the six-month trading range at $485 could be tested and result in a breakout.

Apple is an expensive stock, but traders can play this recovery with the much cheaper iPhone component marker, Cirrus Logic (NASDAQ: CRUS).

The high correlation between the two stocks is apparent in the 52-week performance chart.

CRUS is down 37% in the past year versus the recovering AAPL, which is off about 23%.

The company just reported fiscal first-quarter 2014 adjusted earnings of $0.47 per share, beating Zacks’ consensus estimate of $0.39, and revenue was up 56.7% from the year-ago quarter.

Looking at the chart below, we see that CRUS has three-year support at $12.50. For the past two months, the stock has traded between $22 and $18. An upside breakout of that range targets a move to $26.

The $26 target is about 41% higher than current prices, but traders who use a capital-preserving, stock substitution strategy could make more than 70% on a move to that level.

One major advantage of using long call options rather than buying a stock outright is putting up much less capital to control 100 shares — that’s the power of leverage. But with all of the potential strike and expiration combinations, choosing an option can be a daunting task.

Simply put, you want to buy a high-probability option that has enough time to be right, so there are two rules traders should follow:

Rule One: Choose an option with a delta of 70 or above.

An option’s strike price is the level at which the options buyer has the right to purchase the underlying stock or ETF without any obligation to do so. (In reality, you rarely convert the option into shares, but rather simply sell back the option you bought to exit the trade for a gain or loss.)

It is important to buy options that pay off from a modest price move in the underlying stock or ETF rather than those that only make money on the infrequent price explosion. In-the-money options are more expensive, but they’re worth it, as your chances of success are mathematically superior to buying cheap, out-of-the-money options that rarely pay off.

The options Greek delta approximates the odds that an option will be in the money at expiration. It is a measurement of how well an option follows the movement in the underlying security. You can find an option’s delta using an options calculator, such as the one offered by the CBOE.

With CRUS trading at about $18.40 at the time of this writing, an in-the-money $12 strike call option currently has $6.40 in real or intrinsic value. The remainder of the premium is the time value of the option. And this call option currently has a delta of about 89.

Rule Two: Buy more time until expiration than you may need — at least three to six months — for the trade to develop.

Time is an investor’s greatest asset when you have completely limited the exposure risks. Traders often do not buy enough time for the trade to achieve profitable results. Nothing is more frustrating than being right about a move only after the option has expired.

With these rules in mind, I would recommend the CRUS March 2014 12 Calls at $7 or less.

A close below $16 in CRUS on a weekly basis or the loss of half of the option’s premium would trigger an exit. If you do not use a stop, the maximum loss is still limited to the $700 or less paid per option contract. The upside, on the other hand, is unlimited. And the March 2014 options give the bull trend almost eight months to develop.

This trade breaks even at $19 ($12 strike plus $7 options premium). That is less than $1 above CRUS’ current price. If shares hit the breakout target of $26, then the call options would have $14 of intrinsic value and deliver a gain of more than 70%.

Recommended Trade Setup:

— Buy Cirrus Logic (NASDAQ: CRUS) March 2014 12 Calls at $7 or less
— Set stop-loss at $3.50
— Set initial price target at $12 for a potential 71% gain in 7.5 months

Alan Knuckman


Source: ProfitableTrading