By: John J. Critchley, Jr.
Apple (AAPL) shocked the world and a dedicated legion of devotees with an unexpected earnings miss last week. The earnings event is now over and the summer doldrums appear to be finally upon us. The 4.5% downward move post earnings has been followed by a steady and full retracement of this move and the options marketplace has crushed the implied volatility of Apple options as a consequence.
The 30-day implied volatility (IV) is trading around 22.83%, far from the 52 week implied volatility high of 52.36% hit last October. The 30 day IV low of 18.32% was reached on February 3rd of this year and the current IV is only 3% higher than this low implied volatility watermark.
The chart below that compares 30 day implied volatility (IV) of the options versus the 30 day historical volatility (HV) of the underlying. This is interesting for traders in two aspects:
1) The 30 Day implied volatility (IV) is trading at multi-month lows.
2) The 30 Day historical volatility (HV) of the underlying is trending higher than the 30 day IV. Normally, one would expect to see IV higher than HV. Except for a period of time this spring, the chart below shows a clear pattern of Apple IV trading at a premium to HV.
Why is the IV versus HV so important to traders? Historical Volatility is a backward looking measure of how an underlying has moved over a 30 day period. Implied Volatility is a forward looking measure of the marketplace's expectations for movement in the underlying. When IV dips below HV, it presents an opportunity to buy volatility at a discount to the actual 30 day realized movement of the underlying.
IV is mean reverting. The question is: When will the IV start to mean revert and how can you trade it?
There may be an opportunity to take advantage of these depressed implied volatilities to initiate option positions that nicely fit into your view of the fundamentals of AAPL. If you have a directional view on the underlying, the combination of cheap options and a directional bet can put you at a significant advantage.
Buy or Sell? That is up to up to you, but we present some option plays that may suit whatever investment camp you find yourself in.
Let's look at one for the bulls and one for the bears.
Trade idea #1 - A Bearish Options Play
Apple is rallying nicely today (+2.02%) and has erased all of the losses incurred last week as a consequence of the lackluster earnings report. This may be an opportune time to initiate a short position through some put plays as the 30 day implied volatility is still within shouting distance of the 52 week low. This is usually a bearish sign indicating continuing contentment and complacency in the marketplace.
To find the most compelling near term implied volatility option play, one must has to look no further then the August 18 '2012 monthly options, which presents compelling near term value.
This is not a specific trade recommendation, but a trade analysis.
The play: To take advantage of normal downside implied volatility skew and to benefit from any further downward pressure in AAPL.
a) Buy August 18 '2012 monthly 585-560 put spread for $3.60. Receiving about 2.4% in Implied Volatility skew (buying 21.2 IV vs. selling 23.6 IV)
To finance this spread:
b) Let's sell the August 18 '2012 monthly 640 calls @ 2.20 This is approximately a 21.1% Implied Volatility.
Net debit: $1.40
Why sell the August 18 '2012 monthly 640 calls? There are two reasons:
1) There is a legion of investors and throngs of speculators that believes that the Apple miss was aberration and an one off event and therefore the upside call options are still quite bid. By selling the August 18 '2012 monthly 640 calls at 21.1% IV, you are only giving up a .1% discount to the August 585 puts. This difference is statistically insignificant. Normally, one would see a more pronounced skew (difference) between the OTM (out-of-the-money) puts and calls. Let's take thadvantage of this anomaly.
What is Volatility Skew?
This means quite simply that the out-of-the-money (OTM) puts trade at a higher implied volatility than at-the-money (ATM) puts and OTM calls. Normally as a stock rises a common strategy that is extremely popular with institutions and the public customer is to overwrite (sell) the options against existing underlying equity positions. The basic theory of supply and demand kicks in and drives the prices lower as the liquidity providers lower the price of the options as the supply increases.
2) 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 5.6% between now and August expiration.
Risk: You will be Short the stock over $645. A 6.26% upward move in Apple over the next 3 weeks.
Trade idea #2 - A Bullish Options Play
For the true believers who view this recent selloff in Apple as a buying opportunity, the depressed 30 day implied volatility allows for cheap upside speculation.
In order to accomplish this, one can go to the September 2012 monthly options, which present quite compelling medium term speculation value. Remember, this play also allows you to benefit from a possible positive product announcement before September 21st expiration. There is an Apple Media event all but confirmed for September 12th and the buzz is that Apple will introduce the next -generation iPhone plus the "iPad mini" (Source: click here)
This is not a specific trade recommendation, but a trade analysis.
A) Buy September 2012 monthly 650 calls @ 6.85. Buying 23.4% IV is cheap for 7 weeks of upside plus a possible product announcement. This implied volatility purchase is higher than the regular August monthly expiration options (22.2%), but remember there is a product announcement premium baked (already priced) into these options.
To finance this purchase:
b) Let's sell the September 2012 monthly 555 puts @ 6.0 This is approximately a 25.4% implied volatility. You are selling implied volatility in these puts at a skew premium to your call purchase. This is very normal and standard option pricing behavior. Let's take advantage of the elevated downside implied volatility in these options to lessen the debit of our call purchase.
Net debit: $.85
Risk: You will have AAPL stock put to you @$555. In other words, you will be long and own the stock at $555 if Apple trades lower and you are assigned the puts. A 8.5 % downward move in Apple over the next 2 months.
Stay tuned ...
Notes: Prices quoted where the prices at time of submission and do not reflect current market prices. You are solely responsible for your own trading and investments decisions and the ideas presented in this article are trade analysis, for educational purposes only and do not constitute buy/hold/sell recommendations.
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.
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