Around the time of each earnings announcement at Apple (AAPL), speculators on both sides of the trade gather to listen to the numbers and to read in the earnings call the tea leaves of Apple's future. Already there are articles discussing how to trade the earnings release with options (and in the comments, debates regarding the actual earnings date). Officially, here it is: Apple's third quarter of its fiscal 2012 ended with the close of June, and the earnings release will be July 24 (you can listen here).
Speculators, start your engines.
What's An Investor To Do?
One effect of the influx of speculators -- both in the equity and the options -- is to increase volatility. Any news has the prospect of touching off a sudden price move. And since everyone knows the news is coming on earnings release date, everyone is holding their breath -- and their bets - until they see whether they are right or wrong on their earnings call.
The effect is illustrated in a chart in Richard Bloch's March 5 article advocating May options. In his chart, you can see the implied volatility (that is, the part of an option's value not attributable to the difference between its strike price and market price, or the amount of time left in the option) in Apple plummet on earnings release day, almost like clockwork. I've personally seen call options lose value on earnings day while the stock popped up on good news, simply because the volatility had vanished. Just being right about the direction of the shares is not sufficient to make money in options, when volatility is changing dramatically under one's feet.
One way to game the volatility evaporation is to wait until the market has priced options with knowledge of the earnings date, then sell options in anticipation of volatility collapse. Such a position would seem to have a maximum horizon based on the expiration date of the option -- and therefore a speculative, short-term trade. Why would an investor be attracted to a trade?
Apple is an issue for which options trade not only with monthly expirations, but with weekly expirations. Since the time-premium in each option decays most rapidly at the end of its life, weekly expirations are not a bad place to try capitalizing on premium decay. Recently, this author has had the following experience selling options to put shares of Apple to the author:
AAPL Close at Entry
May 31, 2012
Jun 8, 2012
Put (Strike 570)
Jun 12, 2012
Jun 16, 2012
Put (Strike 570)
Jun 15, 2012
Jun 22, 2012
Put (Strike 570)
Jun 26, 2012
Jun 29, 2012
Put (Strike 570)
Jun 28, 2012
Jul 6, 2012
Put (Strike 565)
Prices for close at entry are from Yahoo Finance; price/share are actual sale prices.
With the exception of the today-expiring options, each has expired worthless: the premium realized at sale has been retained for future use. In the (unlikely) event the option expiring today were to be exercised, the price of the shares purchased thereby would in a sense be $29.40 (less commissions) less than the $565 strike price. Given the author's expectation of holding the shares until China represents a larger share of Apple's global sales than does the United States, the time horizon of the strategy is arguably not the successive one-week periods that have elapsed, but the longer period of the long position any of the options might cause.
There is no shortage of options strategies that seek to offer high percentage upside with moderate downside risk. Many of them might be suitable for traders, but so many appear to require an up-front risk with a possibility of loss of principal that it is hard to consider them without offense to Warren Buffett's First Rule of Investing (as well as his Second Rule). Selling a put option on a stock you are willing to hold a long time, with a strike price that amounts to a good investment price, is not too dissimilar to what Warren Buffett did at Berkshire Hathaway (BRK.A) when he wrote in-effect put options on the major stock indexes. In Buffett's case, they were long-dated nonstandard options capable of being exercised only at expiration; time worked for him because inflation and historic growth trends seemed to promise too much upside for the indexes to suffer a net decline over the decade-plus option period.
Near-dated options are in a way less dangerous, as they are in effect conditional sale orders. Instead of telling your broker, "Buy me shares at $600," one could say, "If they pay me $6 today, I'll buy at $600 anytime within the next week if they like -- but only if I can keep the $6 regardless." In either case, an order might or might not (depending on market conditions) be filled at $600. In the latter case, though, you have $6 to enjoy regardless -- and $6 to put toward that purchase if the order fills. The author has heard naked puts described as "cash-covered" puts to make them sound less dangerous, but has been able to ascertain no difference in price or risk for holders of ordinary margin accounts. Just as with making any equity purchase, each investor must individually determine how many shares to order without creating trouble in one's personal finances.
When The Iron Is Hot
Although the August-expiring option is the monthly option expiring just after the Apple earnings release, there will be a weekly option for sale by July 20, which will expire July 27, just after the earnings announcement. Selling the August option will raise more money, but will expose an investor to anything that might move the share price between July 27 and the August expiration nearly a month later. In either case, closing the position by purchase is available if the day-after prices of the options make short-term profit too good to pass up. This author suggests the weekly put as a bullish way to capitalize on volatility collapse around earnings, provided investors never offer to buy shares in amounts or at prices they would not be happy to hold for several years.
With Apple's P/E under 15 despite a track record of its profit being a string of year-over-year near-doubles, Apple's growth isn't anywhere near done; applying even its currently lackluster P/E to reasonable estimates of next year's earnings easily place one in a near-term (year or less) expectation of making substantial profit on a purchase of Apple at $600. The 15% growth currently estimated by some analysts for 2013 could potentially be delivered by China alone, when the U.S. market for smartphones shows only ~50% penetration and thus significant room for growth.
The prices at which weekly puts will be available at an attractive price over the earnings announcement will be unknown until they go on sale several business days before the earnings release. Until then, this author continues to write puts at prices that make attractive entry points given Apple's underestimated (15% in 2013?) but substantial global sales momentum. Overhanging doubts about Apple's ability to execute following the death of Steve Jobs may continue to make shares attractively priced despite the evidence for some time, and the opportunity created by this doubt is precisely what makes Apple not just a fun story, but an investment.