All of the talk about Apple (AAPL) over the past few days has been centered around the new product announcements, and rightly so. However, everyone seems to have forgotten about the earnings release set for Thursday, which should create even more excitement in the stock than any product announcement.
Apple has done very well in terms of meeting or beating expectations. Over the past 15 quarters, Apple has only disappointed the market once, and that was the most recent earnings announcement on July 24th of this year. Before that, Apple had an extremely impressive 14-quarter streak in which it met analysts' expectations once, and beat expectations the other 13 times.
As an options trader, I want to figure out the best way to take advantage of the volatility created by the anticipation of the earnings announcement. The volatility spike is even more pronounced than usual in a high-profile stock such as Apple. A great way to take advantage of the volatility, while creating a favorable risk/reward ratio, is with a vertical call spread, which consists of buying one call option, and selling another call option at a higher strike price. A vertical put spread, also useful in these situations, consists of buying one put option and selling another at a lower strike. Before we develop a strategy, let's examine what Apple could do, depending on what the outcome of the announcement is. I want to go into this trade with a two-week timeframe in mind, so I'll examine the stock's behavior immediately after the earnings release and for the 2 week period afterward.
First, let's examine the only time in recent history when Apple simply met the expectations of the market, which happened on October 18th of last year. When it comes to Apple, just meeting expectations is seen as a disappointment, and the stock gapped down overnight, from a close of $422.24 to an open of $401.35 the following day, an overnight drop of 5.2%. It then hovered around the $400 level for the next 2 weeks.
Next, we'll look at the past 9 quarters where Apple beat the market's expectations. On average, the stock jumps 3.7% overnight in this scenario. After 2 weeks, the stock holds onto about 2.6% of the gains, a solid upside move.
In the most recent quarter, where Apple disappointed, the share price dove 4.4% overnight, from around $600 to around $574. However, over the next two weeks, the shares rebounded and then some, quickly climbing to the $620 level and staying there for a few weeks.
So, since the events of a miss or simply meeting expectations have proven to be a rarity for Apple, it is safe to say that there is some bias to the upside. My play for a mildly bullish outlook is to buy the November $600 calls (in the money currently) for $31.95 and simultaneously sell the November $620 calls (out of the money) for $21.20. This trade has a net cost of $10.75 and works for a few reasons. First, the trade makes money as long as Apple closes above $610.75, which it already is trading above. This gives you a little downside protection, and the peace of mind of knowing that the last time Apple traded under this price for more than a day was in August. Maximum profit is achieved if Apple is trading above $620, which is less than 1% above the current share price. That's not a big move needed to produce an 86% gain on your initial investment. Another reason this kind of spread works in this situation is that after an earnings release, the out of the money option will lose its time value faster than the in the money option will, which can further widen the spread to your advantage.
In closing, there are several other trades that can be justified using the data presented in this article. As long as you create a favorable risk/reward ratio and provide yourself some protection in the event of a letdown, it's hard to go wrong playing Apple's earnings.
Disclosure: I am long AAPL.