A Cautious But Profitable Apple Earnings Trade

Jan.20.12 | About: Apple Inc. (AAPL)

After the market closed on Thursday, Google (NASDAQ:GOOG) reported earnings. It was a major disappointment (the stock is getting clobbered after hours), with the company missing on earnings-per-share and revenue.

On Tuesday, after the market closes, Apple (NASDAQ:AAPL) is the next technology powerhouse scheduled to report earnings. There is a general misunderstanding that Apple makes very large price moves after reporting earnings, but this is not really the case. I do not recommend placing a "straddle" or "strangle" trade.

Currently, Apple is trading at $427.75. The 52-week range is $310.50 - $429.47.

52wk high: 429.47
52wk low: 310.50
EPS: 27.68
PE: 15.50
Div Rate: N/A
Yield: N/A
Market Cap: 398.73 B
Volume: 9.28 M
Click to enlarge

What I think is important to understand with this upcoming earnings release is that Apple has a tendency to "lowball" future estimates. From a business standpoint, this is actually a savvy move. For a trader, it can present a nightmare scenario, as the stock may move down or up only slightly. Since Apple is a stock that is over $420/share at this writing, even a slight price move can still present a great trading opportunity if the strategy used is the correct one.

I am very bullish on Apple for 2012. I think the stock will surpass $500/share at some point. However, this is an earnings trade and to anyone who has not read any of my previous articles on earnings trades, I always use a neutral strategy than can profit no matter if the stock moves up or down.

The "reverse iron condor" spread is a neutral options strategy that is placed with a net debit instead of a net credit to the buyer, and can be placed with a lower level trading account. Most brokers will let you place this trade if you are approved with a Level 2 or Level 3. Please check with your broker, and if not approved, you can request to be upgraded.

This trade is a limited risk, limited profit strategy. Here is how the "reverse iron condor" trade is placed accurately. (Note: this example is using only one contract each for explanation purposes):

  • Buy 1 OTM Put
  • Sell 1 OTM Put (Lower Strike)
  • Buy 1 OTM Call
  • Sell 1 OTM Call (Higher Strike)

Here is how I will be placing this Apple trade. The "reverse iron condor" has four legs. (Note: you can increase or decrease the number of contracts to suit your preferred investment in the trade):

  • Buy (10) AAPL January Week 4 $425.00 strike put options
  • Sell (10) AAPL January Week 4 $420.00 strike put options
  • Buy (10) AAPL January Week 4 $430.00 strike call options
  • Sell (10) AAPL January Week 4 $435.00 strike call options

Requirements

Cost/Proceeds $8,600.00
Option Requirement $0.00
Total Requirements $8,600.00
Estimated Commission $100.00
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The current bid/ask spread is $4.00 - $4.60. A limit order of $4.30 should get your order filled.

Current Price: $427.75

Price Profit/Loss
$315.00 $1,400.00
$358.90 $1,400.00
$405.11 $1,400.00
$420.00 $1,400.00
$420.70 $0.00
$425.00 (-$8,600.00)
$430.00 (-$8,600.00)
$434.30 $0.00
$435.00 $1,400.00
$451.33 $1,400.00
$543.75 $1,400.00
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The highest profit potential is 16.2% should Apple rise over $435.00/share at expiration or fall below $420.00/share. The two break-even prices are $420.70/share and $434.30/share. When adding in the commission costs to the trade, the profit will still stand at 13.9%, and I am going on the higher end of commission costs to be fair.

This is the only type of trade I would place with Apple's earnings release. Other strategies present too much risk and are one-sided, which is technically gambling when trading earnings.

I will have more articles for earnings trades next week. If you have any questions, please leave a comment or send me an e-mail. I usually respond as soon as possible.

Disclosure: I am long AAPL, GOOG.