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Trading Apple Requires Discipline


Sell within reason and take a hit when you have to.


So I have (hopefully) made it clear that I prefer shorting to buying options premium ahead of an earnings report. You win more often than you lose, but the key point is that the losses can dwarf the winners in magnitude, so you need to manage the trade.

Tyler from Know Your Options had a great write up on Apple (AAPL) options pre-earnings, which basicaly serves as a good primer for any stock. Especially this.

But here's the rub. The times when a stock ends up gapping more than expected can be quite painful for vol sellers. Who cares if I win five out of seven short volatility plays if on the two losers I get steamrolled? In the end I believe this exercise simply reiterates the importance of sound risk management. Though it doesn't take a genius to tell you there's an edge in favor of vol sellers into earnings, it does require at least a savvy trader to play earnings profitably over the long run. Make sure you exercise sound risk management rules like diversification and proper position sizing.

That five of seven was just for Apple on its last seven reports, but those numbers sound realistic for most any name. In fact, if volatility bidups are "fair," the stock should open within a range implied by them about 68% of the time. And the losses should beat the winners roughly such that the expected gain of net-buying should equal the expected gain of net-selling over time.

But it doesn't mean every single report, or every single cycle, is in perfect equilibrium. Bid-ups may be too high early, or too low early, and adjust over the course of a cycle.

The net of this go around looks like a whole lotta nothing. Volatility in general is very low (at least relative to the past year) and bid-ups are rather muted as well.

And as to what Tyler says at the end, I totally agree. Been leaning towards just selling spreads when I sell pre-earnings -- mostly because of that low volatility I just mentioned. Straight premium sales are fine though, I'd just make sure to stay disciplined and take the hit when it goes against you. You don't see too many overnight blasts get reversed in the morning.

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Position in AAPL.
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