Earnings season is rolling on and Apple is due to report earnings on Thursday after the closing bell. The options market is pricing in a 4.2% move in either direction right now. Here's how to set up a bull put spread to profit if Apple stock follows its recent pattern of reactions.
Apple Stock Earnings Are Coming
It's important to consider that Apple stock stayed above the lower expected range following five of the last six earnings announcements. With implied volatility high ahead of earnings, we can structure a credit spread to fit the view that:
- AAPL stock will stay within the expected range.
- The response to the earnings report is likely to be positive.
How do we get the expected range? As discussed previously, we simply take the at-the-money put and call strikes at 170 for the Nov. 3 expiration and add them together. That was just over seven points this morning or 4.2% of the price for Apple stock.
Now that we know the expected range, let's find a bull put spread that has the short strike roughly seven points below the stock price. The closest strike that fits is at 162.50.
So if we sell a Nov. 3 put with a 162.50 strike and buy a 157.50 put at the same expiration, we create a bull put spread.
Profits And Losses For The Trade
This bull put spread on AAPL stock traded around 70 cents this morning. That means a trader selling this spread receives $70 (70 cents times 100 shares per contract) in option premium. Ideally the option expires worthless if Apple closes above 162.50 at expiration. In that case, you keep the entire option premium which is your maximum profit.
Is Apple Stock A Buy Right Now?
What about the risk? Take the difference of the strikes at five and subtract the option premium received. Multiplying again by 100 shares gives a maximum risk of $430. The long put at 157.50 defines the risk and makes that the most you can lose.
That represents a 16.3% return on risk between now and Nov. 3 if AAPL stock remains above 162.50. If Apple closes below 157.50 on the expiration date the trade loses the full $430. The break-even point for the bull put spread is 161.80 which is calculated as 162.50 less the 0.70 option premium per contract.
Understand The Risks
There is little room for adjustment with short-term trades such as this held over earnings. They either work or they don't.
A 16% return in a few days would be nice, but the possibility of losing 100% is also very real.
As such, this style of trade is only for traders with a high-risk tolerance.
If Apple stocks ends below 157.50 at expiration, long-term investors could consider exercising the long put and taking ownership of the 100 shares. With the position already getting acquired at a discount, you could then sell covered calls against it to reduce your basis further.
According to IBD Stock Checkup, Apple stock ranks No. 2 in its group and has a Composite Rating of 79, an EPS Rating of 87 and a Relative Strength Rating of 80.
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
