Apple reports earnings on Thursday after the closing bell, and as such, is showing higher than normal implied volatility. Therefore, let's look at a combination of two options strategies in AAPL stock that would benefit from the market's reaction to the news.
According to IBD Stock Checkup, AAPL stock ranks 2nd in its group and has a Composite Rating of 90, an EPS Rating of 81 and a Relative Strength Rating of 86.
After an earnings announcement, implied volatility tends to drop significantly, reducing option premiums. By selling options before the announcement, traders can take advantage of this implied volatility drop.
AAPL Stock: Getting A Discount With Options
By using a combination of option strategies, we could potentially buy Apple for a significant discount or achieve a healthy profit if AAPL stock trades sideways.
Here's the trade:
First, sell to open the AAPL Aug. 18-expiration put with a strike price of 187.50, which was trading around $1.50 per share on Friday. Then, add a bear call spread. Consider this setup:
- Sell to open the AAPL Aug. 18 call with a strike price of 205, which was trading around $1.20 on Friday.
- Buy to open the AAPL Aug. 18 call with a strike price of 207.50, which was trading around $0.75 on Friday.
The sold put brings in around $150 in option premium, and the bear call spread adds another $45 in premium. In total, the combination of the two trades in AAPL stock generates $195 in premium per set of contracts.
Delta Watch
The position starts with a delta of 15, meaning it is roughly equivalent to owning 15 shares of AAPL stock.
This figure will change as the trade progresses in AAPL stock.
Let's work through a couple of scenarios of how this trade could look at expiration on Aug. 18.
- If AAPL stock trades sideways and finishes between 187.50 and 205, the sold put and bear call spread will both expire worthless. The total profit will equal the premium received of $195.
- If AAPL stock falls below 187.50 at expiration, we will get assigned the sold put and forced to buy 100 shares at 187.50. However, our net cost basis will be 185.55 per share, thanks to the $195 in option premium received. That is 5.5% below the stock price of 196.45 at Monday's close.
- If Apple rallies above 207.50, the bear call spread will suffer a full loss of $250. But this gets mostly offset by the $195 premium received, leaving the trade with a small loss of $55.
This options combination trade is a unique way to play a neutral to slightly bullish outlook for Apple earnings.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ.
