Looking forward to the Cupertino tech giant’s earnings, it seems that the market might be understating how much the stock price might move. With the price at all-time highs, a big move could be warranted. Here’s how to profit.
For options traders, the experience of earnings season is similar to the one kids may feel walking into their favorite toy store. There are so many compelling choices, and it’s hard to know where to begin. It can be exhilarating and overwhelming at the same time.
But unlike making a toy purchase, the stakes are much higher when choosing an options trade for a company’s earnings results. You don’t get a second chance once the results are out. And, there can be quite a bit of money on the line.
That’s where I can help.
Last week, I discussed a straddle trade for software giant Microsoft (NASDAQ: MSFT). This week, we’ll be turning our attention to the biggest company of them all, Apple (NASDAQ: AAPL). Apple’s earnings will be released after close tomorrow, Tuesday, May 2nd.
As one of the largest and most important companies in the world, AAPL earnings will be closely monitored by investors. How has the company been performing? Are iPhone sales up or down? What does it mean for consumer spending? What are the next products on the way? These are just a few of the many questions AAPL watchers will be asking as earnings hit the wire.
And let’s not forget, AAPL also offers a dividend. Will the company possibly increase the dividend? Are share buybacks on the table? These sort of events can also have a significant impact on the price of the stock.
So how do you trade options on a stock with so many variables involved? In the case of AAPL, the multitude of factors potentially impacting the stock price suggests the stock has a higher probability to move more than the market expects. In fact, current expectations (as measured by the straddle price) are for AAPL shares to move 3.7% (in either direction).
I don’t know about you, but that seems awfully low to me. Looking at earnings history, the numbers support my belief. Over the last 7 earnings periods, there’s only been one quarter where the stock moved less than 3.7%. In most cases, the move (the day after expiration) has been closer to 6% on average.
Fortunately, options give us a very straightforward method to buy movement without actually having to pick a direction. Like we did with MSFT last week, we could also purchase the at-the-money (ATM) straddle for Apple in the options expiring this Friday. Currently, the ATM straddle (buying the call and put at the same strike price in the same period) costs $5.25, or $525 per straddle.
As I said before, I think that’s super cheap for an earnings week straddle in AAPL. However, I mean cheap from an implied move standpoint (of just 3.7%). From an absolute value standpoint, you may feel that dropping $525 per straddle is too rich for your blood. In terms of a payout, the stock (with a current price of $144) would have to drop below $138.75 or climb above $149.25 in order to make money on the trade.
Conversely, you could save some upfront money by purchasing a strangle instead. The strangle functions similar to a straddle but you’re buying out-of-the-money options instead of the ATM strike. It lowers your cost, but can reduce your return potential to some extent.
For example, you could purchase the 141-147 strangle (141 puts, 147 calls) for about $2.75 or just a bit over half the cost of the straddle. With this trade, your breakeven points are $138.25 and $149.25. So, the stock would have drop a little more to make money on the downside, but the upside breakeven is exactly the same as the straddle. Most importantly, you’re only paying $275 per strangle compared to $525 per straddle.
If you think AAPL is going to move more than roughly 4% after earnings, and you want to keep your costs low, I would recommend the 141-147 strangle. It’s a great way to buy into a possible big earnings move without having to spend a lot of money upfront on the straddle.