This earnings season has been dubbed the “Tech Wreck.”
With Facebook, Netflix, Google and Amazon all weaker after earnings, will Apple (AAPL) be able to turn around tech or be the catalyst that pushes the Nasdaq off a cliff? Either way, this presents an opportunity to trade the earnings event, bullish, bearish or neutral. Today I’m going to cover four different ways to play the earnings announcement using options.
The first way is to buy a straddle, looking at the Aug. 3 expiration cycle, the closest strike to the current price of $189.91 is the 190 strike. The market makers are well aware of the large moves expected around earnings. That’s why with only three days until expiration, the options are pricing in a $6.89, or a 3.6 percent move in either direction.
The expected move can be found by taking 85 percent of the straddle price of $8.10. By buying the straddle, or a call and put at the 190 strike, the total risk in the trade is $810.00, and AAPL would need to drop below $181.90 or rise to above $198.10 for this trade to be profitable. The probability of profit is only about 41 percent.
With a straddle, imagine an upside down triangle: Anything outside the triangle would be profitable, but anywhere inside, between $181.90 and $198.10, would be unprofitable. The gains are in theory unlimited, but it will take an outsized move to overcome the breakeven points.
If you’re bullish AAPL, you could sell the 182.5 put and buy the 180 put. This trade has a max profit of $44 and a max risk of $206. However, it also has a 78 percent probability of profit. AAPL would have to go all the way below $182.06 for this trade to lose money. That’s nearly the same level as it would be for the straddle to be profitable, which is why between the two, this is a much higher-probability trade.
Now maybe you’re bearish.
You could sell the 197.5 call and buy the 200 call. This trade has a similar risk profile to the put spread above that risks $204 to make $46, and has a probability of profit of 79 percent. Considering that if you were to short one share of AAPL it would take roughly the same amount of risk, you would need a $46 dollar move in AAPL or a 24 percent down move, to where the short share would be more profitable than this call spread.
Finally, we could combine the call spread and put spread together to make an iron condor. This may be the best option of the four as the risk-reward is highest in this scenario. The max profit on the trade is $91 and the max risk is only $159. This also has a probability of profit of 60 percent with the breakevens at $181.59 and $198.41. With a potential return of 57 percent within three days and only $159 in risk, this presents itself as the most advantageous scenario of the four.
So while having unlimited potential may sound great, buying the straddle puts five times as much capital at risk and the breakeven is nearly the same as both the call and put spread breakevens. Trading earnings can be exciting but tough as we saw in NFLX, it had a large drop early on then was nearly flat by the end of the day.
With the earnings announcement set for after the markets close on July 31, we will see which way the AAPL crumbles.
Christopher M. Uhl, CMA, MOSM