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Apple's Implied Volatility: Long and Wrong?

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Going into earnings with any kind of long option position (puts or calls) seems a low odds bet.

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I spent a stupid amount of time over the weekend charting various options outcomes for Apple's (NASDAQ:AAPL) earnings release, and regardless of where I looked the conclusion seemed always the same: Going into earnings with any kind of long option position (puts or calls) seems a low odds bet. That applies not just to the weekly options for April 26 and May 3 expiration, but for the May and June monthlies as well. The reason is that implied volatilities are very high this time around, and if the post-earnings volatility collapse follows form, it would take an inordinate move to just break even.

For example: The monthly May 390 puts sport an implied volatility of 43.03% and a delta of 0.49. This means that if implied volatilities remain unchanged post earnings and you were "delta neutral" (in this case long 100 AAPL shares and long two of the May 390 puts) your breakeven prices on April 30 (an arbitrary date I chose) would be $416 on the positive side and $366 on the negative side. Now, getting outside those boundaries already entails a pretty sizable move, but it is not crazy. However, that implies no change in the options' implied volatility post earnings. Should the implied volatility collapse to where it ended after past earnings releases – in the 20 to 25% range – one would need a move above $429 or below $356, just to break even. There's roughly an 80% chance that such a move will not happen.

If one agrees with the above, the corollary should be that "selling" volatility should be an "easy" money-maker. But in my opinion, that's far from the case, especially when it comes to selling calls. So far the volatility of the stock has been dictated primarily by investors' perceptions of the fundamentals and valuation of the company. If that were all that was in play, I would probably be comfortable buying the stock at $356 or shorting it at $430, (for a swing type trade) because I don't think there's any major fundamental development coming from AAPL that the market is totally oblivious to. But what is not in the option prices, and cannot be quantified, is what AAPL may do with its cash. Should AAPL decide to buy back its stock in size and/or increase its dividend, once the expected stock-halt is lifted, $430 may well look like a generational "buy" opportunity, and if one is short calls, it means pain beyond recognition. And throw in the completely meaningless but widely embraced game of "stock-splitting" and I can already hear split-adjusted calls for AAPL at $1,000.

As to selling puts, that's somewhat more manageable if one is resolute in owning the stock at a pre-determined lower price. Charts show important levels at $377.68 (DeMark monthly Level Down "support"), $390 and $320 (Fibonacci 50% and 61.8% retracements of the '09-'12 move), and the most important of all, the $352.50 level where everyone can say "the damn thing got cut in half, it's gotta be a buy." Since it began its face-plant, AAPL so far has laughed at every level of support, so factor that into the equation, but for willing buyers, those prices are reasonable reference points.

Last week I wrote on the Buzz & Banter (subscription required) that I had positioned myself with options and expected to profit from more than a $10 move either side post earnings. Revisiting those positions in light of a steep volatility crunch shows them to be likely losers, so I will close them out. Whether I set up something more along the thinking described above will likely be a last second decision.

Twitter: @FZucchi

Also see:

Why You Might Be Sharing a Cubicle With Your Windows Phone


Apple's Alliance With Yahoo Makes Sense, but Don't Expect Breakup With Google
Position in AAPL
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