AAPl Earnings Preview with Skew Patterns

Discussion in 'Options' started by livevol_ophir, Apr 20, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    AAPL is trading 245.39. Earnings are today after the close.

    <img src="http://4.bp.blogspot.com/_hMry1m7UF10/S821gBG4CTI/AAAAAAAAB4E/22uSKdK5ybE/s1600/aapl_summary.gif">

    AAPL has followed a trading pattern that yields a winning strategy 7/8 earnings cycles. I'll demonstrate it below, then tell you why this time may be different.

    <b>A few things we probably know with earnings vol:</b>
    (1) Vol will rise into the event
    (2) Vol wil drop after the event
    (3) The stock will move that day more than average

    The Earnings & Dividends Tab snap is included (in the article or <a href="http://livevol.blogspot.com/2010/04/aapl.html"> here</a>).

    <b>What we're lookin' at:</b>
    (1) The top ROW is AAPL stock price 5 trading days before earnings through 5 trading days after.
    (2) The second ROW are the front 2 month ATM straddles for the same period - focus on purple - the front month.
    (3) The third ROW is the implied vol for those straddles - focus on the red - the front month. NOTE: The red line always collapses after earnings - this is called the vol crush after earnings.

    The simple strategy of selling the front month straddle right on the close and buying it back the next day after earnings on close has yielded a nice win 7/8 last earnings. The stats are included.

    <img src="http://3.bp.blogspot.com/_hMry1m7UF10/S8229fsWmnI/AAAAAAAAB40/4RKqZkF-p0I/s1600/aapl_e_stats.gif">

    You can see an average 11% one day gain which is pretty sweet. Given the liquidity in AAPL, slippage is minimal. These numbers do not include commissions. Also, if this strategy was employed selling the straddle two days before earnings, the results are even better.

    Even though this strategy won 7/8 times, here's why I think it might be different this time. First, the Skew Tab snap for today is included (in the article or <a href="http://livevol.blogspot.com/2010/04/aapl.html"> here</a>).

    You can see the front month vol (red line) is above the other months. The Options Tab snap (in the article) illustrates the exact month-to-month differences (at the top).

    It looks like the front is 3 IV points higher than the second month (32 vs. 29) and 2 IV points higher than the third month (32 vs. 30).

    Now we can look at the Skew Tab snap for 1-20-2010 (the day of earnings in the last cycle).

    <img src="http://2.bp.blogspot.com/_hMry1m7UF10/S821h5JXTjI/AAAAAAAAB4k/IyBcI8ZudbU/s1600/aapl_skew-1-20-2010.gif" width = "450">

    We see here that the front month (red) is substantially higher than the other months. Specifically it's 6 IV points higher than the second month (yellow) and 7 IV points higher than the third (green). The absolute ATM front month IV is 46 compared to 32 today.

    The Skew Tab two days after shows the massive vol crush (in the article or <a href="http://livevol.blogspot.com/2010/04/aapl.html"> here</a>).

    To read what vol skew is and why it exists you can <a href="http://livevol.blogspot.com/2010/01/solarfun-solf-call-purchases-with.html">Click Here</a>.

    What's happened is that AAPL vol has moved with the market. The VIX has come in substantially as the market has rallied. The difference in the straddle is huge. With AAPL trading around 205, the straddle was $20.33. Now, with AAPL trading $245, the 240 straddle has fair value $18.60 and the 250 straddle has fair value $18.40, so we'll call it $18.50 fair value.

    Just to clarify. Using sort of rough math:

    $20.33 last time --- Would be the same as ---> $24.54 this time

    In other words, with the straddle sitting at $18.50, that's $6 cheaper than last time, or ~$25%. Just as easily we could just have compared the IV differences (46 to 32).

    <b>So what does this mean?</b>
    1) I shoulda sold the damn straddle last time!
    2) It's not as clear cut this time.

    If you do back spread this straddle (buy it), note that about half the time AAPL stock wanders further away from the strike within a few days after earnings. So in that sense, you may have a "second" chance if it doesn't move big on earnings.

    Other than straddles, I see some butteflies sitting up there if you think AAPL will go to a strike - like $260 or $230 (or whatever). Some nice 8:1 payouts and the such.

    This is trade analysis, not a recommendation.

    Details, earnings, vols, skews, charts, prices here:
  2. livevol,

    After you posted this, I took a quick look at AAPL options and
    decided to try this idea:

    Long Strangles + Short Farther Strangles
    or, it could be called a Reverse Long Iron Condor
    It is of course a Bull Call spread and Bear Put Spread.

    Here is what I opened on 4/20:

    Long 250 call - 6.77
    Short 260 call - 3.48
    Bull Call Spread cost = 329

    Long 240 put - 6.70
    Short 230 put - 3.35
    Bear Put Spread cost = 335

    Total cost per = 664

    Today with Apple hovering around 270, I sold out for:

    Long 250 call - 21.66
    Short 260 call - 13.79
    Bull Call Spread value = 787

    Long 240 put - .72
    Short 230 put - .34
    Bear Put Spread value = 38

    Total credit per = 825

    So, the return was 24% in 2 days. Not too bad. I had no idea what direction AAPL would move, so I wasn't about to do a directional bet. Obviously the long strangles alone would have been better, but that is always easy to see in hindsight of course. Since May expiry is still a ways off, I figured the max loss per position here wouldn't be too large (I didn't look at the exact numbers if IV fell x% and so on, but I didn't see near the money options taking too hard of a hit in any event).

    I would guess that AAPL will stay over 260 for May, so I could have held on and waited for more time to expire out of the 250/260 spread, but I just felt that it was a bit risky in case it didn't because the 240 put wouldn't be much of a hedge as May expiration would get closer. And sometimes gaining 24% in 2 days can be as nice as 35% in 30 days for example.

  3. livevol_ophir

    livevol_ophir ET Sponsor

    Great news, congratulations on the winning trade - always great to hear!