Apple Earnings — Shrewd Options Plays Are Tough to Come By

by Tyler Craig | July 23, 2013 12:05 pm

The next catalyst for Apple (AAPL[1]) shares is nearly upon us. The battered tech titan reports its third fiscal quarter tonight after the bell. The Street expects Apple earnings per share (EPS) to come in around $7.30.

AAPL chart -- Apple Earnings
Click to Enlarge

Year-to-date AAPL shares have been foundering. While the stock’s recent successful retest of major support at $390 was a short-term bullish omen, it has struggled to tack on additional gains.

Though shareholders may be relieved that AAPL is finally showing some stability after its harrowing descent from $700, consolidation in an environment where the S&P 500 index is making new highs seemingly every day leads to drastic underperformance.

AAPL:SPY Ratio Chart -- Apple Earnings[2]

We can view a ratio chart of AAPL vs. the S&P 500 to see just how relentless the relative weakness has been over the past year.

Time will tell whether tonight’s announcement will act as the catalyst to finally jump-start the stock. Bulls are hoping it doesn’t follow in the footsteps of other recent tech bigwigs like Google (GOOG[3]), Intel (INTC[4]), and Microsoft (MSFT[5]). All three disappointed the Street and were punished accordingly.

While predicting directional moves into an earnings release is a fool’s errand offering virtually no edge — and a mere coin flip’s chance of success — we can gauge market expectations for the magnitude of the move with a high degree of accuracy.

The life of an earnings volatility forecaster became much easier following the advent of weekly options. These short-term options provide a more accurate method for measuring volatility expectations over the coming few days. Though there are multiple techniques used to determine the anticipated size of the earnings gap, many options junkies use the price of a long straddle position, which consists of buying an at-the-money call and put.

The current price of the July 425 weekly straddle on AAPL is $19.75, which effectively means the stock is expected to rise or fall about 4.7% by Friday. Of course, since these options don’t expire until the weekend, they include tonight’s Apple earnings plus three full days of trading. So the expectations for just the post-earnings jump are obviously less than 4.7%. Whether you think AAPL is going to move more or less than this will dictate if you want to be a buyer or seller of options heading into tonight’s main event.

IV chart -- Apple Earnings
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To add further color to the analysis, we might assess an implied volatility (IV) chart of AAPL options to compare the current volatility bid-up to prior quarters. All it takes is one look to reveal options players are expecting few fireworks tonight. The average IV level heading into the past four Apple earnings announcements (blue “E” icons on the chart) was 40%. This time IV received nary a bump and sits at a lowly 30%.

The low levels of implied volatility mean that option sellers really don’t have much margin for error here. Most would-be volatility traders are probably better off watching Apple earnings from the sidelines. The conditions are such that few attractive plays really exist.

At the time of this writing Tyler Craig owned shares of AAPL.

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