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Over the weekend, I wrote an article where I presented several options trades ahead of Apple's (NASDAQ:AAPL) earnings call. I had a straightforward intent: To see how different contracts act and react when the options market reopens the day after a major event. For one reason or another, several readers had a problem with my experiment.

Here are the options trades I laid out for comparison:

Long Call Options

  • Buy 1 AAPL May 2012 $500 call for $79.80.
  • Buy 2 AAPL May 2012 $570 calls for $31.20.
  • Buy 9 AAPL May 2012 $640 call for $8.65.
  • Buy 1 AAPL Jan 2013 $500 call for $113.00.
  • Buy 1 AAPL Jan 2013 $570 call for $74.60.
  • Buy 2 AAPL Jan 2013 $640 calls for $46.10.

Long Put Options

  • Buy 13 AAPL May 2012 $500 puts for $5.70.
  • Buy 2 AAPL May 2012 $570 puts for $28.25.
  • Buy 1 AAPL May 2012 $640 put for $76.30.
  • Buy 2 AAPL Jan 2013 $500 puts for $41.50.
  • Buy 1 AAPL Jan 2013 $570 put for $73.40.
  • Buy 1 AAPL Jan 2013 $640 put for $115.05.

It's probably my fault, but it seems several folks misunderstood some key points about what I was trying to do:

  • I was not putting on some crazy multi-legged options trade; rather, I want to look at each position in isolation.
  • I am not trying to become more famous than Black and Scholes. As is the case with a good number of my options articles, I just want to help people new to options get their heads around the basics. Some experienced investors have never used options, but there seems to be widespread interest building.
  • This is not as simple as AAPL goes up, calls win, puts lose or AAPL goes down, calls lose, puts win. That much is obvious, though the trajectory is not always quite so clean. Instead, I want to look at two of the things that dog options beginners: Deciding between ITM, ATM and OTM strikes and choosing a close-in or long-dated expiration month.

As we review the outcomes of individual trades, I hope more than a few people get something out of this exercise. There's no question that a few of us have made ill-advised options trades in the past.

While both can be instructive, let's use the puts here not only because they represent the (horrifically) wrong directional bet, but to consider the differences between being stuck with ITM, ATM or OTM puts with May 2012 or January 2013 expirations. If you own an AAPL call this morning, particularly one that is now ATM or ITM, chances are you are doing just fine.

ContractEntry, 4/20Close, 4/24Exit, After Open, 4/25Change, Entry to Exit
AAPL May 2012 $500 PUT$5.70$5.56$0.65-88.6%
AAPL May 2012 $570 PUT$28.25$30.45$5.70-79.8%
AAPL May 2012 $640 PUT$76.30$84.55$37.46-50.9%

If you already know everything there is to know about options, skip to the end of the article. But, for those new to options, I think we have useful information. If nothing else, it helps to see how things play out. Hopefully, you'll remember this data prior to entering your next directional earnings-related bet.

Buying puts on AAPL ahead of earnings was a bad move. The contracts got decimated across the board. This much is obvious. What I was more concerned with going into this exercise - and remain more concerned with - is how different options contracts compare to one another post-earnings.

At day's end, you would probably be wise to stop yourself out of any of the three above positions, but, for illustration purposes, let's assume you want to salvage some losses because you anticipate near-term weakness in AAPL. Again, this is all for illustration. I would not short or buy puts on AAPL right now for more than a day trade with my worst enemy's trading platform.

In the OTM puts, you have no intrinsic value (amount of the premium ITM) whatsoever. All you have is what will quickly become rapidly eroding extrinsic value (time premium) with May expiration just 24 days away. In the ITM $640 put, however, intrinsic value comprises roughly $25.00 of the premium; time premium makes up the remainder of the $37.46.

If AAPL stayed at its current price come expiration, you would have intrinsic value to hang your hat on. You can sell to close that $640 put prior to expiration and collect that intrinsic value. And, if AAPL were to drop, intrinsic value increases, helping offset some of your steep losses.

I am not a big fan of making directional options bets ahead of or through earnings, particularly on a stock like AAPL, which can easily move 10% in either direction. However, if you're going to do it opt for the trade that will not completely wipe you out if you are wrong. If you cannot afford the more expensive, ITM contract, you do not belong in the trade at any strike.

Time decay is your enemy. Intrinsic value is your friend.

Now, let's look at the same strikes, but with January 2013 expirations.

ContractEntry, 4/20Close, 4/24Exit, After Open, 4/25Change, Entry to Exit
AAPL Jan 2013 $500 PUT$41.50$40.20$27.15-34.6%
AAPL Jan 2013 $570 PUT$73.40$73.09$48.30-34.2%
AAPL Jan 2013 $640 PUT$115.05$119.10$90.70-21.2%

The Jan 2013 puts show a much more orderly decline (and less steep). This is because they do not expire for roughly nine months AND because implied volatility, compared to the May 2012 puts, was not as high prior to earnings and did not have as far to fall.

Heading into earnings, the AAPL May 2012 $500 put sported IV of about 67. It dropped to 40 at the open Wednesday morning. Contrast this to the AAPL Jan 2013 $500 put, which saw IV drop from about 43.5 to around 36 overnight. Changes in IV at all strikes between the two expirations are pretty much constant across the board.

When IV falls, option premiums decrease with it.

We'll like conduct a similar exercise in conjunction with Apple's next quarterly report.

Source: Comparing Apple Earnings Trades After The Fact