Apple (AAPL) is due to report earnings next week. Google (GOOG) has already reported positive earnings which should build excitement for other stocks in the tech sector, such as Amazon (AMZN), Microsoft (MSFT), and especially Apple.
In a previous article the behavior of Apple's stock during earnings week was analyzed. The article presented past earnings performance, the movement in the stock price, and the rise in implied volatility. This information was used to evaluate the effectiveness of various option strategies.
Strategies
Three different strategies of buying and selling straddles during earnings week were evaluated for their effectiveness at creating a profit. A strangle is when an option trader buys both a put and a call option at the same strike price and date of expiration. The strategies analyzed were weekly options. Even though a strangle was evaluated other bi-directional option spreads such as straddles, butterflies, and condors would likely have similar results as those of the straddle presented herein.
Strategy One: Sell Before Earnings and Hold Through Expiration
The first strategy evaluated was selling a straddle and holding it through expiration. This was motivated by the fact that Apple stock does not historically have significant price swings during earnings week and the implied volatility peaks before earnings release. The limited change in price and implied volatility was shown in the previous article. By selling a straddle the investor is hoping to profit from the time decay (theta) associated with the option premium. When selling just before earnings release the investor is hoping to capture as much implied volatility in the option price (VEGA) as possible and therefore collect as more option premium.
Earnings Date | Strike | Price | Expiring Value | Profit/Loss | Profit/Loss Percentage |
January 24 2012 | 420 | 22.875 | 27.28 | -4.405 | -19.26% |
October 18 2011 | 420 | 19.775 | 27.13 | -7.355 | -37.19% |
July 19 2011 | 375 | 18.475 | 18.3 | 0.175 | 0.95% |
April 20 2011 | 340 | 14.425 | 10.69 | 3.735 | 25.89% |
January 18 2011 | 340 | 14.975 | 7.32 | 7.655 | 51.12% |
October 18 2010 | 320 | 23.625 | 12.53 | 11.095 | 46.96% |
July 20 2010 | 250 | 13.275 | 9.94 | 3.335 | 25.12% |
This strategy proved to be quite profitable in the past however this has not been the case for the past few earnings reports. In the past couple of earnings reports Apple has delivered both a miss and an incredible beat. In an attempt to better understand the results the option price as a percent of the strike price was calculated. A larger percentage the more the stock will need to move before the option seller begins to lose money.
Earnings Date | Strike | Price | Option Price as a Percent of Strike Price |
January 24 2012 | 420 | 22.875 | 5.45% |
October 18 2011 | 420 | 19.775 | 4.71% |
July 19 2011 | 375 | 18.475 | 4.93% |
April 20 2011 | 340 | 14.425 | 4.24% |
January 18 2011 | 340 | 14.975 | 4.40% |
October 18 2010 | 320 | 23.625 | 7.38% |
July 20 2010 | 250 | 13.275 | 5.31% |
As one can see in the above table the option premium received is frequently less than 5% of the strike price. This table was observed to see if a pattern existed between the percentage and the profit but no such pattern was observed. The profitability of this strategy appears to be contingent on luck. It isn't advised to utilize this strategy.
Strategy Two: Sell at Creation and Hold Through Expiration
The second strategy involved selling a straddle at creation and holding it through expiration. This strategy was also motivated by the fact that Apple does not have a history of substantial price movement during earnings week. This stock movement during earnings week can be seen in the previous article. By selling the spread at creation rather than before earnings the investor will collect less premium associated with implied volatility but instead will collect more premium from more time decay (theta).
Earnings Date | Strike | Price | Expiring Value | Profit/Loss | Profit/Loss Percentage |
January 24 2012 | 430 | 22.425 | 17.28 | 5.145 | 22.94% |
October 18 2011 | 410 | 22.625 | 17.13 | 5.495 | 24.29% |
July 19 2011 | 360 | 16.775 | 33.3 | -16.525 | -98.51% |
April 20 2011 | 330 | 16.9 | 20.69 | -3.79 | -22.43% |
January 18 2011 | 345 | 15.25 | 12.32 | 2.93 | 19.21% |
October 18 2010 | 300 | 16.925 | 7.47 | 9.455 | 55.86% |
July 20 2010 | 250 | 17.775 | 9.94 | 7.835 | 44.08% |
This strategy can be both profitable and costly. It is interesting that both of the two recent earnings releases were profitable. However this could be because in each case the stock moved favorable between the date of creation and the earnings release. It is also worth noting that the two least profitable dates occurred when the implied volatility at creation was quite low. The option price as a percent of the stock price was also calculated.
Earnings Date | Strike | Price | Option Price as a Percent of Strike Price |
January 24 2012 | 430 | 22.425 | 5.22% |
October 18 2011 | 410 | 22.625 | 5.52% |
July 19 2011 | 360 | 16.775 | 4.66% |
April 20 2011 | 330 | 16.9 | 5.12% |
January 18 2011 | 345 | 15.25 | 4.42% |
October 18 2010 | 300 | 16.925 | 5.64% |
July 20 2010 | 250 | 17.775 | 7.11% |
The above table shows the option price as a percent of the stock price. The first thing that is noticeable is that the premium tends to be a slightly greater percentage of the strike price than in the first strategy. However profiting from this strategy appears to still be a matter of luck.
Strategy Three: Buy at Creation and Sell Before Earnings
The third strategy is to buy a strangle after the creation of the weekly options and sell it before earnings are released. This strategy is motivated by the noticeable increase of implied volatility before the earnings release. The increase in implied volatility before earnings can be seen in this article. An investor utilizing this strategy is hoping that the value of the option associated with rising implied volatility will be greater than the value loss to time.
Earnings Date | Strike | Initial Price | Expiring Value | Profit/Loss | Profit/Loss Percentage |
January 24 2012 | 430 | 22.425 | 23 | 0.575 | 2.56% |
October 18 2011 | 410 | 22.625 | 22.225 | -0.4 | -1.77% |
July 19 2011 | 360 | 16.775 | 22.92 | 6.145 | 36.63% |
April 20 2011 | 330 | 16.9 | 18.52 | 1.62 | 9.59% |
January 18 2011 | 345 | 15.25 | 15.1 | -0.15 | -0.98% |
October 18 2010 | 300 | 16.925 | 27.525 | 10.6 | 62.63% |
July 20 2010 | 250 | 17.775 | 13.275 | -4.5 | -25.32% |
This strategy has shown the ability to be quite profitable. The only significant loss was back in July 2010. It can also be assumed that by properly timing trade entry and exits a better return could probably be achieved.
Combine Strategies One and Three
An investor can also combine both strategies one and three because one trade will close as the other trade is opened.
Earnings Date | Strategy Three Profit | Strategy One Profit | Profit/Loss | Profit/Loss Percentage |
January 24 2012 | 0.575 | -4.405 | -3.83 | -17.08% |
October 18 2011 | -0.4 | -7.355 | -7.755 | -34.28% |
July 19 2011 | 6.145 | 0.175 | 6.32 | 37.68% |
April 20 2011 | 1.62 | 3.735 | 5.355 | 31.69% |
January 18 2011 | -0.15 | 7.655 | 7.505 | 49.21% |
October 18 2010 | 10.6 | 11.095 | 21.695 | 128.18% |
July 20 2010 | -4.5 | 3.335 | -1.165 | -6.55% |
This combined strategy has shown the ability to be incredibly profitable; however, it is important to remember that half of this strategy is highly dependent upon luck.
Conclusions
The first two strategies can be highly profitable but they appear to be driven by a great deal of luck. The third strategy is a safer and a more reliable option strategy. Significant profits can be made using the third strategy but they are unlikely to be as substantial as either of the first two strategies. A wise investor shouldn't be tempted to chase the larger profit, because it is far more like gambling than investing.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL, GOOG, MSFT, AMZN over the next 72 hours. I have an iron condor trade currently open in AAPL that is expiring at the end of this week. I may initiate non-directional trade on any of these stocks at any time.
