Selling volatility can be a dangerous game, but it can also be a very rewarding one for options traders. Apple Inc. (NASDAQ: AAPL) is a winner yet again after blowing out its earnings estimates. What is interesting is where the stock is today versus the last Apple earnings report, and what the ongoing opportunities are for those willing to write options by selling volatility into earnings.
About three hours before the Apple earnings report, an at-the-money August $250.00 strike price straddle (put and call) ran right at $24.00. Based on the pricing of the puts and calls and with shares slightly under the $250 strike it looked as though options traders were expecting a move of $12 to $13 in either direction. Shares are up ‘only’ about $8.00 now at $259.20 but the high of the day is roughly $265.00.
That straddle now only costs $21.00 if you break out $15.00 for the Call and almost $6.00 for the Put. Apple does not usually move more than 10% after earnings on the announcement, but selling volatility by writing that $250 straddle would have netted out much more in come. This same thing happened last quarter. What is interesting about this notion is that the only thing you have to be right about is that Apple holders won’t bid the stock up or down more than 10% after the earnings.
The idea at hand is to pick stocks that you think are less likely to have as wild of moves that are still deemed high-beta and active shares. Netflix (NASDAQ: NFLX) is on deck for earnings this week, as are Baidu, Inc. (NASDAQ: BIDU) and Amazon.com Inc. (NASDAQ: AMZN). We all know that Netflix and Baidu can be incredibly volatile into and after earnings reports.
The most volatile, and therefore the riskiest, is Netflix. With shares at $121.75, you can actually spread this out to the August $125 Call and $120 Put. The $125 Call could be sold for $7.00 and the $120 Put can be sold for $7.40. After collecting the premiums, your bet is only that Netflix does not fal under $105.60 or rise above $139.40. The reason this is the riskiest is because it has a very high post-earnings volatility and there is likely going to be a stock split announced at the earnings report today or in the near-future.
Baidu at $76 leaves the closest straddle strike at $75 for August. The straddle can be sold for over $10.00, broken down as $5.00 for the Call and $4.60 for the Put. As long as you don’t have a run above $85 or a drop to under $65 you win. The risk-reward matrix there is actually only a “weak positive” based on its volatility after earnings.
Amazon.com generates a less-exciting premium of “only” $12.00 by selling volatility via the August $120 straddle. With shares at $120.15, writers of options can collect $6.05 for the Call and $6.00 for the Put. Call it $12.00 for rounding. If Amazon.com does not rise above $132 or fall under $108, you win. While Amazon.com is still down 20% from its 52-week highs and up over 55% from iits 52-week lows, each day this is a more and more mature company. Theory is dangerous to rely upon as fact when valuations are still elevated, something that cannot be ignored.
The real trick is when you “place your bet.” Selling a strike too far ahead of the earnings event leaves you market risk, which is not something that is recommended for volatility bets based on a static snapshot into a single event. Generally, this is something that should be handled in the last hours before the event. If the volatility dwindles or spikes and if the price handles change, strategies have to adapt to those changes.
As of this writing, Jon Ogg did not own a position in any of the stocks named here.
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