The $400 Question: Should You Buy Apple Ahead Of Earnings?

Jan.10.12 | About: Apple Inc. (AAPL)

I receive lots of email through Seeking Alpha. People ask about options. People tell me they hate me. Some tell me they love me and want to take me "away from all of this." A few want to talk hockey. While those queries continue to pour in by the dozen, something else now dominates the correspondence:

Should I go long Apple (NASDAQ:AAPL) ahead of earnings? Or, more precisely, should I buy AAPL calls ahead of earnings?

My first, and ultimately, final response - that's a very personal decision. Don't even check with your financial adviser or Donna Chang. As much as I respect and generally heed the words of fellow Seeking Alpha contributor Andy Zaky, don't listen to him either.

Nobody, except for true Apple insiders (e.g., Tim Cook and, probably still, Steve Jobs) can tell you with any certainty how the company's earnings will turn out on January 24th. But, more importantly, even if the inner circle did divulge insider information to mere mortals, even they could not tell you what will happen to Apple's stock in the aftermath of its quarterly report.

Most long and short scenarios trigger considerable anxiety in a situation like this. And they should. So much uncertainty exists and if you end up on the wrong side of the trade, you could get crushed. Even if you set a stop loss, AAPL could very well trade through it, particularly if you have an open option contract that does not reset until the morning after earnings. On the flip side, you'll likely kick yourself if you do nothing, yet the stock does exactly what you thought it would do.

The following trades represent little more than illustrations of how you could proceed ahead of earnings, though, the best suggestion might just be to not proceed at all.

Write A Covered Call

If you own AAPL already, particularly with a cost basis south of $400, you're likely in the best position. Because the January calls expire prior to Apple's earnings report, you could always double dip.

Write the January $430 call and collect, as of intraday Tuesday, roughly $2.90. Of course, if AAPL closes in-the-money at expiration (close of trading January 20th, expiration is, technically, the 21st), you could get your shares called away. If not you could turn around Monday morning (the 23rd) and write another out-of-the-money call for February. As of intraday Tuesday, the $445 strike sports a bid of $7.10.

If you don't own AAPL, want to, but hesitate fearing a pullback, you could execute a buy-write strategy to get in with a bit of a hedge. For example, at this moment (9:44 a.m. Pacific Time, Tuesday), I could buy 100 shares of AAPL for about $422 a share ($42,200) and sell/write the AAPL March $445 call for approximately $10.65 (credit of $1,065).

The call sale generates income and lowers the effective price of my AAPL shares to $411.35. If AAPL pulls back post-earnings, I've got a bit more breathing room than had I just placed an order for the stock and bought it for $422 without the covered call income.

In-The-Money Long-Dated Call Options

I'm not even going to bring up specific contracts because, sadly, most people will get tempted by the allure of "cheap," out-of-the-money, near-term calls and buy that lotto ticket. Sure, AAPL could rally to $450 after earnings and stay there. You'll be "rich." Or, the person that sold you calls could benefit. It's truly a zero sum game.

If you're going to play this report with calls, make it more of an investment than a wholly speculative trade. I argue not going closer in than July and buying something slightly or deep in-the-money. Sure, you pay more for the cushion of time and intrinsic value, but you pay more for good reason. There's a much better chance your calls will end up in-the-money at expiration than on the near-term lotto tickets that cost much less.

This is one of the key points I pound home in greater detail in my basic options strategy eBook. OTM calls are less expensive for the same reasons the payoff on a futures bet that predicts a Stanley Cup victory for Columbus is higher than the payoff the same $1 will get you if you put it on Vancouver. It's all about the likelihood that something will or will not happen. You pay a premium for the opportunity to profit from an options trade with a higher probability of success, holding all else constant.

Disclosure: I am long AAPL.