Apple July Earnings Play Hinges On The Final Days

Jul.23.12 | About: Apple Inc. (AAPL)

With an increasingly dour macro-economic backdrop, one might expect a very large response to Apple's July earnings report (coming July 24th after the market closes). It seems that Apple (AAPL) is primed to produce a major disappointment relative to high company-specific expectations or a tremendous, odds-beating surprise relative to deteriorating global economic conditions. However, the trading action going into Tuesday evening's earnings report was very lukewarm until today (Monday, July 23). Unlike the April earnings where the data gave me extreme confidence in a large upside response, the trading going into July earnings is not yet producing clarity. Indeed, this time around, I will likely need to wait until the hours or minutes before the close preceding earnings to make a final decision. Until today's sell-off that took AAPL down as much as 2.5%, I had concluded it was better to leave Apple alone for this round.

In the rest of this piece, I describe the factors I am considering. Please reference the previous Apple earnings play analysis, "Odds Favor A Big One-Day Upside After Apple Posts Earnings", for more background and related charts.

Before the April earnings report, a large sell-off leading into earnings triggered my interest in analyzing AAPL as an earnings play. The 8.9% one-day gain that followed that report was as extreme as the preceding sell-off. Apple next lost as much as 16% before finding a bottom in mid-May, two weeks before the NASDAQ bottomed from its sell-off. The stock returned to its post-earnings highs in early July, but it has mainly bounced between there and the $600 "tripwire" since then. At the time of writing, Apple has broken below $600 again, but a close above that will maintain the primary range; the stock has bounced sharply above the lows to retest the $600 level.

Apple mainly trades in a tight range going into July earningsClick to enlarge
(Click to enlarge)

Apple mainly trades in a tight range going into July earnings

Source: FreeStockCharts.com

Through Friday's trading, AAPL's one-week average daily pre-earnings price change was a very boring 0.0%. Its two-week average daily pre-earnings price change was 0.25%. Since 2007, the only time AAPL traded flat in the one-week prior to earnings was a 0.0% performance going into the July, 2010 earnings. Apple only increased 0.9% the day following earnings. The average two-week performance was also tepid at 0.1%. The post-earnings performance for a near flat, but positive, two-week performance is a mixed bag with a rare 0.5% loss after the January, 2011 earnings and a 6.0% leap after the April, 2010 earnings. What remains to be seen is Apple's one-day price change on Tuesday, directly ahead of earnings. While there is little correlation between the one-day price change preceding earnings and the one-day post-earnings price change (0.2), this relationship has turned negative (inversely correlated) since 2010. (Refer to "The Odds Deliver As Post-Earnings Apple Breaks April's Downtrend" for the updated charts showing Apple's pre-earnings correlations including April, 2012).

Recall that the two overall lessons from the analysis of the Apple earnings play are that 1) AAPL produces distinct patterns based on the quarter of the earnings report, and 2) the overall correlations have changed since 2010. Overall, Apple tends to produce positive responses to earnings. Since 2007, 16 of 22 earnings reports produced positive one-day responses. The July earnings stands out as the only month where Apple's 2-week pre-earnings price performance is positively correlated (a relatively strong 0.7) to the one-day post-earnings response. Both January and July produce positive correlations for the 1-week pre-earnings price performance, but July's correlation is not strong. I did not include this chart in the previous post, so here it is for your review:

Correlation of AppleClick to enlarge
(Click to enlarge)

Correlation of Apple's 1-Week Average Daily Pre-Earnings Price Change to the One-Day Post-Earnings Price Change Sorted By the Month of Earnings

So, it seems the Apple earnings play essentially hinges on the final two days before the report. Here are the scenarios that will define my decision:

  • If Apple closes within the trading range ahead of earnings, I will not play earnings. I will instead focus on potential post-earnings plays.
  • If Apple closes above or well below the trading range ahead of earnings, I will assume the odds favor the positive correlation with the 2-week daily average for July earnings. Specifically, a close below $590 makes me bearish, and a close above $620 makes me bullish.

(Note that I will tweet my final decision.)

Be careful out there!

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours. I may instead initiate a short position in AAPL over the next 72 hours.