Friday afternoon I wrote a preview of Apple’s (AAPL) Q2 earnings due out today after the close (read here) and detailed a hedging strategy for long holders of the stock in the post and on Friday’s Options Action in CNBC, watch below:
With just hours to the print, and Alphabet’s (GOOGL) revenue miss last night resulting in the stock’s nearly 8% decline today from an all-time high, I thought it might make sense to offer a couple of other ways to play, with defined risk for those with a directional view post-earnings.
Lets first refresh the implied move with the stock down 2% today, trading near $200, the options market is implying about a 5% move in either direction by next Friday’s close, or about $10. The stock on average has moved about 6% the day after its last four quarterly reports, which does not include its 10% one day drop of January 3rd, 2019 following their first earnings pre-announcement in more than a decade.
It is important to remember what exactly the “implied move” is and how we figure it. Out, when looking at an event move we can take the at the money straddle (the call premium + the put premium), which in the case of AAPL we would take the May 3rd weekly 200 call offered at about $5 and the put premium offered at about $5. If one did not have a directional view but did think the stock could move a lot, then you could buy the at the money straddle but would need a move of at least $10 by Friday’s close to make money. But buying a straddle into an event like earnings is a hard way to make a living, in this case getting more than a 5% move in the next three trading days is not exactly a high probability bet. With the stock at $200, the at the money straddle at $10, then by Friday. To look at the probability of success for that trade then you could look at the May 3rd 210 call and the May 3rd 190 put and you see that the options market is only saying there is about a 20% probability of the stock being at 210 or 190 on Friday’s close. To repeat not a great probability of success.
I would add that if you had a directional inclination (aka high conviction) then half of the implied move via the call or the put could be the way to play, In this case if you thought the stock could rally more than the value of the at the money call, or decline more than the value of the at the money put, then if you bought the at the money call or put then you would only need a $5 move or about 2.5%.
One way to increase the probability of success on a directional bet by buying the at the money call or put could be to turn into into a call spread, targeting the implied move. For instance…
Bullish with the stock $200.50, targeting the implied move of $210, you could buy the May 3rd weekly 200 – 212.50 call spread for $4, buying 1 May 3rd call for $5.50, sell the May 3rd 212.50 call at $1. This call spread breaks even at $204, offers a max payout of $8.50 at $212.50. This trade idea is in the money, offers a potential payout of a little more than 2x the premium at risk, Again the probability of max payout is less than 20% in 3 trading days.
On the flip-side, Bearish, if you thought the stock will test $190, in line with the implied move down towards $190 then you might consider the following put spread…. with the stock at $200.50, the May 3rd 200 – 190 put spread is offered at $3.45, buying 1 of the May 3rd 200 puts for $4.80 and sell to open 1 May 190 put at $1.35. This trade breaks even at 196.65 and offers profit potential of up to $6.65 if the stock is $190 or lower on Friday’s close. Nearly a 2 to 1 potential payout if the stock is down 5%, again, and ok risk reward.
I’ll offer our usual disclaimer about long premium directional trades into potentially volatile events like earnings, you need to get a lot of things right to merely break-even, first and foremost direction, then magnitude of the move and obviously timing.
Also, with the stock near $200 I want to quickly update the hedge idea from Friday, as I mentioned in the note on Friday these are the sort of strategies you need to get the strikes right, meaning not putting them on too early prior to the event. With the stock at
vs 100 shares of AAPL long at $200.50 Buy May 17th 190 – 210 Collar for 30 cents
-Sell to open 1 May 210 call at $2.10
-Buy to open 1 May 190 put for $2.40
Break-even on May expiration:
Profits of the stock up to 210, gains capped above. If the stock is above 210 on May expiration the investors could always cover the short call to keep the long position in place.
Losses of the stock down to 190, protected below 190
Rationale: this trade idea targets the implied move in the stock post-earnings and is meant to give a sense of defined risk.
Again, the tradeoff is a limit to the potential upside for potential downside protection.