Apple (AAPL) is expected to report earnings on Monday, July 16. As with all earnings reports, it is extremely difficult to predict both the numbers that will be reported and the amount and direction of the stock's reaction to the numbers. Instead of buying or selling a lottery ticket on Apple's earnings report, we can analyze the market's expectations of the earnings move as well as the change in those expectations over time, also known as implied volatility of Apple options.
Implied volatility is a statistic derived from the market price of options. The higher the IV, the more volatility option traders are expecting from the stock, and the higher the premium of the options. Therefore, if we are long an option position and the implied volatility increases, the price of our option increase as well (how big of a price increase is determined by the option's vega, the amount that an option contract's price changes in reaction to a 1% change in the volatility of the underlying asset).
In order to form an expectation of Apple's implied volatility in these weeks before earnings, we look at how the IV has trended before their last seven earnings reports.
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The following is the percent increase in implied volatility in the above time frames:
| Oct '10 | Jan '11 | Apr '11 | Jul '11 | Oct '11 | Jan '12 | Apr '12 |
| 43.57% | 46.46% | 0.07% | 20.88% | 24.29% | 19.92% | 36.46% |
Another point supporting our thesis of increasing IV is that Apple's current IV of 22 is at the low range of its 52-week IV, as the 52-week high is 53.8 and the low is 19.4.
A trade to profit from this expectation of rising IV is to buy an at-the-money calendar spread, which profits from a rise in implied volatility. In this trade we sell an option in the current month and buy the same strike option in a back month. The two statistics important in this trade are vega, which is the effect of changes in implied volatility, and theta, the rate at which an option loses its value over time (time decay).
Strike | Price | Vega | Theta | ||
Sell | Jul 12 Call | 585 | $11.75 | -0.56 | 0.30 |
Buy | Sep 12 Call | 585 | ($30.95) | 1.11 | -0.19 |
($19.20) | 0.55 | 0.11 |
We have both positive vega, meaning our position will profit from a rise in IV, and positive theta, so our position will slowly gain value with the passing of time (our long call loses value slower than our short call). Please note: IV always plunges the day after an earnings report; this is because the uncertainty surrounding the earnings release has been removed. The point of this strategy is that the trade is closed before the numbers are released.
The position should be closed two to three days before earnings. This allows sufficient opportunity for time decay and IV changes but eliminates the risk of any last minute surprise moves.
The risk in this trade is that Apple moves too far in either direction, and our maximum loss is the $19.20 paid. An additional risk is that our expectation proves wrong and IV moves lower, though with IV only 2.5 above the 52-week low - that would be a surprise.
Disclosure: I am long AAPL.
