Apple (AAPL) earnings are on tap for Thursday (10/25/12) after the close. This is an announcement that will not be taken lightly. We are now over one year since the passing of Steve Jobs and Apple continues to push out products. Some argue that Apple has lost the innovative touch it once had. We just had the release of the iPad Mini which was a disappointment to most due to the high price. Can Tim Cook step in and fill Steve Jobs' shoes?
Apple has moved off of its highs in the 700s to trade down at 616.
By looking at the at-the-money straddle expiring this Friday we can see people are expecting a $31.75 move, or about 5% from the current price.
So what do we do, get long, short?
Typically it is not a good idea to get short with straddles into earnings. A lot of people like to try to get short straddles because of the drop in volatility after earnings are announced. However, the market is very efficient at pricing earnings moves. When they are wrong the reaction will typically overshoot what the market expected.
So now we know not to get short but what about going long? With volatility already elevated Apple would have to really surprise on earnings for a straddle to pay off. I don't see any real edge here in volatility.
One of the trades we could look at is placing an iron condor. I want to look at the November 540/545 700/705 iron condor.
The Iron Condor is a limited profit play, but it is also a limited risk play. The idea is to get the underlying to fall between the short strikes or in our case the 545 and 700 strikes.
We are looking at a 0.88 ($88 an iron condor) credit which should yield us a nice 21% return on this play.
We figure by taking the return and dividing it by margin required for the position.
88 / 412 = 21.35%
Our strikes are approximately 11-13% away from the current market price. So as long as Apple stays above 545 and below 700 this play will profit. Volatility will come out of this play quickly and as long as the price falls in line it will be a solid return. This should give us enough room in case the market mis-prices Apple earnings.
On the other side if Apple blows out earnings or really surprises we can lose up to $412 on each iron condor we put on. We figure this out to be the difference between the spreads and subtracting the credit.
705 - 700 - 88 = $412
Obviously we are risking more than the reward but the probability of taking a loss is slim. With volatility already so elevated we are more likely to fall in line with the 6% the straddle is predicting. Big blow outs typically happen when volatility is lower and people are not expecting a big move.
The idea of this play is to play the earnings announcement and play the drop in volatility. I will look to either close Friday or if the stock really goes nowhere then I will hold it into the beginning of next week to get some more time and volatility decay. This is meant to be a fast play so you are not really looking to hold into expiration.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.