Apple: Speculative Earnings Plays

| About: Apple Inc. (AAPL)

By: John J. Critchley, Jr.

The wait is almost over. Apple (NASDAQ:AAPL) kicks off earnings week as the technology powerhouse reports after the bell Tuesday and many expect another blockbuster quarter. The consensus estimate for the third-quarter earnings is $10.37 a share, a whopping increase of over 25% from the same period last year. (Source: Click Here)

The unofficial number that is 'whispered' on the street is closer to $ 11.63 a share. (Source: Click Here)

Apple has made a habit of blowing away even the highest expectations. Last quarter, Apple destroyed the estimates with $12.30 a share, more than 20% above the street estimates.

If we look at Apple's past history with earnings reports there is reason to believe that Tuesday's release will be a bullish one. The technology juggernaut has not often missed an estimate. Out of the last 8 earnings reports, the only miss was on 10/28/2011. However, it is how Apple responds after reporting earnings that is most paramount. In this aspect, Apple also has a tremendous record. The shares have gone higher in the following week in the past five earnings releases, with the underlying booking an average weekly gain of around 5.8%.

Source: Livevol(NYSE:R) Pro (

The analyst community is in mad love with Apple. There are 53 analysts that follow Apple and out of these independent thinking people, 49 rate Apple a Buy/Outperform, 4 have it as a hold and only 1 heretic rates Apple a sell. The consensus price target: $727.00.

What camp are you in and will the love fest continue after the earnings are announced? We present two option plays - one for those inclined to believe that the stock will have an outsized move, but aren't sure which way it will go and one play for the courageous ones who dare to task a bearish stand.

Options Plays

What makes playing Apple's earnings quite tricky is that the company has a history of nearly always beating the street estimates and nearly always rising post-earnings. That is the bullish case. On the other hand, the company is sitting near record highs and even a minor revenue shortfall or lowered revenue/earnings forecast and the stock could collapse. That is the bearish case.

Confused on what to do with the earnings? Long or short? How about playing both ways?

With Apple trading only 6.75% off its all time highs, the implied volatility of the options is quite a distance from its 52 week highs. The 30 day implied volatility is trading around 33.61%, significantly less from the 52 week implied volatility high of 52.36% hit in October of last year.

Let's take advantage of these reasonable implied volatilities to initiate a position that takes advantage of any post-earnings move in the underlying. If you believe this scenario may play out, let's buy a straddle.

This is not a specific trade recommendation, but a trade analysis.

Trade idea #1-A Long Options Volatility/Premium Play

To find a pure earnings option play, one could go out to the July 27 2012 weekly options, which present some interesting short term value.

The play:

a) Buy July'27 2012 weekly 605 straddle for $32.40. The implied volatility of this straddle is seemingly quite high at approximately 52.4% IV (Implied Volatility). This IV reading is, however misleading because the most important determinant of an options real value as it gets closer to expiration is the premium only, not the actual IV% reading. The premium over parity (POP) number of $32.40 is what is really important in this case.

Net debit: $32.40

Why the July 27 2012 605 weekly strike line? You are buying the At-the-Money (ATM) straddle for $32.40. The breakevens for this straddle in the underlying are $637.40 and $572.60 respectively. These breakeven points represent a 5.3% move in the underlying. This percentage move does not appear to be unreasonable especially considering that you are buying "event premium" plus the heightened volatility of the market as a whole. Remember, the average weekly gain for AAPL post-earnings is around 5.8% on the upside. On the downside, if there is ever even a slight miss of the estimates, the stock could certainly fall quite precipitously.

Risk: The earnings report does not cause the expected movement in the underlying. Be forewarned. You may lose the entire premium. This play is for speculative monies only.


Trade idea #2 -A Bearish Options Play

The play: To take advantage of abnormally low downside implied volatility skew and to benefit from any downward pressure in Apple before earnings. There is normally a very pronounced downside implied volatility skew present in Apple weekly options. This skew is not present this earnings period. It was if everyone was waiting for the "big miss" that never came. They have given up on the downside. Maybe this time a big downward move will happen. The shoe will eventually drop and when it does, it will be very, very ugly. If you believe this scenario may play out, let's initiate a bearish position.

This is not a specific trade recommendation, but a trade analysis.

The play:

a) Buy July 27 2012 weekly 570 puts for $ 4.70. This is approximately a 54.4 % Implied Volatility.

To finance this put purchase:

b) Let's sell the July 27 2012 weekly calls 635 calls @ 3.10 This is approximately a 46.3% Implied Volatility.

Net debit: $1.60

Why sell the July 27 2012 weekly calls 635 calls?

If your bearish view is incorrect, you still may be able to get away with being short some upside calls as you only start to feel some real pain if Apple rallies nearly 5.8% between now and this Friday's expiration. As stated earlier, the average weekly gain for AAPL post-earnings is around 5.8% on the upside.

Risk: You will be short the stock over $635 and have unlimited upside risk. A 5.8 % upward move in Apple in the next few days.


Stay tuned ...

Note: The Prices are quoted at time of submission and do not reflect current market prices.

Disclaimer: We are not liable for any trading decisions made by any reader. NO advice is given or implied. The information offered in this article is for demonstration purposes ONLY and should not to be either construed as an offer or considered to be a recommendation to buy or sell any options.

Your use of this information is entirely at your own risk. It is your sole responsibility to evaluate the accuracy, completeness and usefulness of the information. You must assess the risk of any trade with a professional broker, or financial planner, and make your own independent decisions regarding any trades mentioned herein. This is not a solicitation to buy or sell any options, or to purchase or sell any credit spreads. Trading options only carries a high degree of risk, is not suitable for all traders/investors, and you may lose all of your premium money invested in the options. If you have never traded options before, we strongly recommend that you read a little background information made available by the government. Only you can determine what level of risk is appropriate for you. Also, prior to buying or selling an option, a person must receive a copy of Characteristics and Risks of Standardized Options.

Past performances DO NOT guarantee future results. Please consult with your own independent tax, business and financial advisors with respect to any trade. We will NOT be responsible for the consequences of anyone acting on this purely demonstration material.

Important Note: Options involve risk and are not suitable for all investors. For more information, please read the Characteristics and Risks of Standardized Options.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.