New Earnings Trade

• stevenplace
• April 20th, 2010

AAPL

AAPL releases earnings tonight after the close, and I’m looking to play it by selling volatility. Let’s start with the technical thesis:

Overall, AAPL is in a very strong uptrend. There is support from the 20 day and the 50day, as well as previous resistance from early march that should become support. There’s very little in terms of resistance as it is hitting fresh highs, but there is a 161.8% fibonacci extension target around 275– this is measured from the 2008 highs to the crash lows. I feel that there is enough weakness in tech and that earnings have been “baked in,” similar to what we’ve seen in IBM. However, I’m not expecting any huge downside move as any strong pullback will be bought.

Now let’s take a look at the volatility:

The 30 day IV is not that high, but it is relative to the actual volatility seen in the market. In fact, the IV-HV differential is the same comopared to the other earnings dates. We normally see about a 10% drop in IV30 post earnings, so that would give us an expected range of 237-261. I calculated this by looking at the breakeven from the May 250 straddle if it loses 10% of its IV.

The front month (red) volatility skew is fairly steep. That means traders are willing to pay higher relative premiums on lower priced strikes. This evidence leads me to believe that selling put spreads makes sense. However, I will combine it with a call spread to reduce the capital needed– so we are getting into an iron condor.

SELL -2 VERTICAL AAPL 100 MAY 10 270/280 CALL @1.04 LMT ASK

SELL -2 VERTICAL AAPL 100 MAY 10 230/220 PUT @1.58 LMT ASK

These prices were based on Monday’s close, they may be less going into today’s open. Ideally, I want a fill of 2.50, but I’ll take 2.25.

Here’s the risk profile:

Risk: 1476

Reward: 524

Return on Risk: 35%

Breakevens: 227.44 and 272.58

Depending on what the earnnigs move is like, we may exit a single side of the trade and hold the other.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

Tickers: aapl

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