Apple Earnings to Cut Options Volatility

by Adam Warner | April 20, 2011 9:52 am

Want to win a free Ipad? All options trading[1] investors have to do is guess where Apple (NASDAQ: AAPL[2]) will move tonight after earnings. And oh yeah, you have to design a trade that will make you enough money to buy one.

What does Mr. Market expect?

Well, here’s a look at 30-day Implied Volatility in AAPL (basically the May option volatility) vs. 20-day realized volatility in AAPL itself.

To the naked eye, options look considerably overpriced. They carry a 30-ish volatility, while AAPL itself chugs along at a high teens volatility. But of course they price in a possible earnings gap. And whatever AAPL does tonight, we know that implied volatility will implode. How far? Well, that’s the $799 question.

AAPL implied volatility hit a low of about 20 back in February. I would think that’s pretty much a floor now as AAPL itself is perking up a bit lately. So let’s say IV in AAPL declines to 22 after the earnings.

We can then take volatility estimate and apply it to AAPL May options going forward and determine how far AAPL would have to move to tonight to essentially offset the volatility decline. I personally just plug in delta neutral strangles and see where I break even when I move the implied volatility to where I expect it to go. And in AAPL, that tells me the market expects maybe a 6% – 7% move tonight.

Now big caveat. I did this exercise before trading started today. So it’s possible options volatility moves a few points between now and the bell. If volatility lifts, that obviously suggests the market expects a larger move than the 6% – 7% I came up with. Today’s gap also highlights the danger of looking at earnings expectations too soon. You have to remember the stock will move on its own before the number.

Follow Adam Warner on Twitter @agwarner.

Source URL: https://investorplace.com/2011/04/apple-earnings-to-bump-options-volatility-aapl/

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