Tuesday, April 20, 2010

Apple (AAPL) - Earnings Preview with a Pattern

AAPL is trading 245.39. Earnings are today after the close. The LIVEVOL™ Pro Summary is below.

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.

A few things we probably know with earnings vol:
(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 (click to enlarge).

What we're lookin' at:
(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 (click to enlarge).

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 (click to enlarge).

You can see the front month vol (red line) is above the other months. The Options Tab snap (click to enlarge) 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).

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 (click to enlarge).

To read what vol skew is and why it exists you can Click Here.

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).

So what does this mean?
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 that 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.

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