Gadget guru Apple Inc. ( AAPL ) has attracted quite a bit of speculation recently, and with good reason. First, shareholders rejected the publication of a succession plan for CEO Steve Jobs at a recent meeting. Then, the company unveiled its new MacBook Pro lineup , sporting an Intel Corp. ( INTC ) CPU and an Advanced Micro Devices ( AMD ) graphics chip. In today's trading, speculators have spread their attention across a broad range of near-the-money puts and calls. Most interesting, however, was activity at Apple's March 360 and 365 calls, and its March 320 and 325 puts.
Drilling down on today's volume, we find that it is most likely related to the initiation of a larger spread position. In fact, a block of 147 contracts traded on each of the aforementioned four strikes at about 10:58 a.m. Eastern time on the International Securities Exchange (ISE), and were marked "spread" -- supporting the theory that this activity was initiated by the same trader.
Taking a closer look reveals that the March 320 puts and the March 365 calls traded at the ask prices of $1.28 and $0.41, respectively, while the March 325 puts and the March 360 calls changed hands at the bid prices of $1.78 and $0.70, respectively. Given this information, it would appear that we are looking at a potential iron condor on Apple.
The Anatomy of an Apple Iron Condor
What is an iron condor? Basically, this options trading strategy involves entering a bearish call credit spread and a bullish put credit spread. Much like a credit spread, the goal of an iron condor is for all options involved to expire worthless, allowing the trader to retain the entire net credit received at initiation. In other words, the objective is for all of these options to close out of the money, requiring the security to remain in a narrow trading range. For more information on iron condors, click here .
In AAPL's case, the trade breaks down like this: The speculator paid $18,816 for 147 March 320 puts, and shelled out $6,027 for 147 March 365 calls. Meanwhile, the trader received a credit of $26,166 by selling 147 March 325 puts, and pocketed another $10,290 by selling 147 March 360 calls.
So, we have a bearish call spread between the March 360 and 365 strikes, and a bullish put spread between the March 320 and 325 strikes. At this point, the trader has banked a total credit of $11,613. The breakdown for this iron condor is listed below:
Now, don't let this mass of calls and puts confuse you too much. The general principle of this AAPL iron condor is for the shares to close between the $325 and $360 levels by the time the options expire . Such a finish would mean that all of the options involved expire worthless, thus allowing the trader to retain the entire premium.
The iron condor has two breakeven points . The first breakeven point of $324.21 is found by subtracting the net credit received ($0.79) from the sold March 325 strike. The second breakeven point of $360.79 is arrived at by adding the net credit received ($0.79) to the sold March 360 strike.
The maximum gain is equal to the total premium received -- $11,613. The maximum loss, in the event of a downside move, is limited to the difference between the March 320 and 325 puts, minus the net credit received. In the event of an upside move, the maximum loss is limited to the difference between the March 365 and 360 calls, minus the net credit received. In this case, the maximum loss is the same following a sharp move in either direction, with the trader losing out on $4.21, or $421 per contract -- (325 - 320) - $0.79 = $4.21.
Below is a chart for a visual representation:
After the iron condor is established, rising implieds become a considerable liability. The main concerns in this position are the sold March 325 puts and the sold March 360 calls. An increase in implieds for these options will increase their prices, making it much more expensive to exit the positions, should the trader need to buy them back. Furthermore, since the whole point of an AAPL iron condor is for the stock to remain stagnant, rising implied volatility is also a negative as it suggests an increased possibility of a price swing for the shares.
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