Apple stock

Apple Inc. (NASDAQ:AAPL) is reporting earnings tomorrow. Many await to hear the quarterly results and the outlook from the country’s largest company by market cap. Apple Inc. (NASDAQ:AAPL) stock is down approximately 20% since the company reported earnings 90 days ago. There is a divergence of opinion among analysts regarding the quarter. However, for all those brave enough, options could be a ‘safer’ way to ‘play’ AAPL’s earnings. Brian P. Donlin, CFA, FRM, an analyst from Stifel Nicholas has an investment idea using options for Apple Inc. (NASDAQ:AAPL) earnings.  We summarize the idea below:

Sell Feb 1st 465 Put for $6.75 and Buy Jan 25th 515/535 Call Spread for $5.90

Options for Apple Inc. (NASDAQ:AAPL) are pricing in a 6.97% move, according to Bloomberg. The previous four quarters’ AAPL earnings moves have been 0.91%, -4.32%, +8.87%, and +6.24%, respectively. Jan 25th expiring options implied vol is a blended rate of about 95%, and AAPL Feb 1st expiring options implied vol is a blended rate of about 60%, and both could drop to the low-40%/high-30% level after the report.

With only two days left to expiration after the AAPL report, there will be little time value left in the Jan options, so looking at implied volatility before and after the report could be more useful for gauging the premium built into AAPL’s expected earnings move, as opposed to option pricing after the fact. Feb 1st option premium levels are also largely driven by the implied earnings move, but there is a portion of time value built into the options that makes selling a 61% implied vol level attractive as a pure form vol trade, as well as to replicate a directional bias.

Stifel’s post earnings vol assumptions are based on their view of go-forward fundamentals, comparisons with company peers, as well as analysis of historical implied vol and realized vol over the applicable time periods, adjusted for seasonality and the macro environment. 10-day historical vol is 37.06, 30-day historical vol is 33.75, 50-day historical vol is 37.04, and 100-day historical vol is 32.83.

This trade is a way to leverage the potential upside that could come after AAPL earnings announcement as well as take advantage of an attractive entry point, while providing a downside cushion. There is no net cash outlay for this strategy as it results in a $0.85 credit. The potential established cost basis would be $464.15, which is a 6.98% cushion from the current price, if the stock were to sell off and close below $465.00 on expiration and you were assigned shares from your short put.

The maximum gain on the AAPL call spread would be $20.00 if the stock closes at or above $535.00 on expiration, which is an attractive return profile when you can finance the total cost of the call spread. The upside on the trade is owning the 515/535 call spread for free in an up move. If AAPL closes between $465.00 and $515.00, the gain would be $0.85, and the downside risk is owning the stock at the potential established cost basis of $464.15.

With option pricing being elevated going into earnings, many investors like strategies that are close to being option premium neutral, keeping in mind the stock has a pattern of having significant moves on earnings. Some of the underlying criteria here focuses on  the premium levels being sold and the difference in premium levels between strikes. This strategy satisfies both of those criteria.

Disclosure: No position in AAPL