Apple (NASDAQ:AAPL) reports earnings on Tuesday, January 24, 2012 after the market close. In my previous Apple article I demonstrated why buying either puts or calls just before Apple's earnings report is, on average, a losing proposition. This article got a lot of attention. Philip Elmer-DeWitt featured the article in his Fortune blog and called it "one of the most sensible Seeking Alpha articles I've read some time". Not every day you hear such compliment from someone like Philip Elmer-DeWitt.
My favourite way of playing earnings is taking advantage of the rising IV (Implied Volatility) of the options before the announcement. I buy a straddle - At-The-Money (ATM) call and the ATM put with the same expiration or a strangle -Out-Of-The-Money (OTM) strikes. In case of higher priced stocks and/or close expiration, I might buy an OTM strangle and sell a further OTM strangle, creating a Reverse Iron Condor. The trade would be closed before earnings to avoid IV crash.
Below is the history of the Apple's post-earnings moves in the last eight cycles:
Here is the AAPL Volatility chart:
I circled the area of the previous earnings. As we can see, the IV spike was very significant before the previous earnings releases.
For AAPL pre-earnings trade I'm going to buy a Reverse Iron Condor using weekly options expiring few days after the announcement. With the stock currently trading around $425, the trade is:
- Sell AAPL January 2012 Week4 410 put
- Buy AAPL January 2012 Week4 415 put
- Buy AAPL January 2012 Week4 435 call
- Sell AAPL January 2012 Week4 440 call
I'm planning on placing the trade on Thursday when the weekly options become available. The stock price might be different by then, so the strikes might change. In general, I prefer to use long options with deltas in the 25-30 range. The trade will benefit from rising IV and/or movement of the stock. It has to be closed before earnings.
Here is another way to play the post-earnings IV crash. I described it here. The idea is to reverse the first trade just before earnings but with further strikes. Looking at February expiration we can execute the following trade:
- Buy AAPL February 2012 375 put
- Sell AAPL February 2012 380 put
- Sell AAPL February 2012 470 call
- Buy AAPL February 2012 475 call
Here is the P/L graph of the trade:
The trade can be done for about $1.00 credit. The margin requirement is $400 hence the maximum gain is 25%. The trade is resilient to 10.5% move of the stock in either direction. However, be aware that this might be a more risky trade. If the stock moves more than 6-7% post-earnings, the trade might be in trouble. It didn't happen in the last two years, but it doesn't mean it cannot happen this time. However, going to February expiration gives you some caution. If you want to be more aggressive, you can move the strikes five points closer to the current price and get more credit for higher potential return.
I outlined this trade in one of my previous articles. If you followed it, you have just made 13% in one week. You might want to exit now and re-enter just before earnings to take advantage of the higher IV.
Trading options is all about probabilities. You want to make money without guessing what the stock will do. Earnings are always 50/50, as we have seen after the last Apple earnings when the stock pulled back 6%.
"If you have an approach that makes money, then money management can make the difference between success and failure…I try to be conservative in my risk management. Risk control is essential." - Monroe Trout
Additional disclosure: I'm planning placing the AAPL Reverse Iron Condor within the next 72 hours