Trading Apple: How to Play Options Betting on Better-Than-Expected Results

Last week, my colleague Enis Taner and I did a fairly deep dive webinar (seen below) on how we were thinking about the setup into Apple's (NASDAQ:AAPL) Q1 earnings slated for after the market close on Wednesday, January 23. We ran through many of the inputs we use both from a qualitative and quantitative perspective to arrive at our trade structures, and frankly, not much has changed since last Monday.

The implied move for earnings (January 23 post close) has ticked up a tad, though, now about 7% (with the stock at $500, the January 25 500 straddle is offered at about $38, or a little over 7%). So here’s the trade:

My thought here is that the implied move makes sense from the standpoint of the stock’s massive relative weakness, recent sentiment shift, and all of the uncertainty surrounding the rate of decelerating growth. As a trader, my sense is that the sentiment shift of late is a bit overdone, and while the stock could still see $450 on a meaningful Q1 miss and guide below current consensus, I imagine buyers would step in at levels that represent a round trip of the historic 12-month run.

While investors want to look out past the recent weakness, and anticipate catalysts such as share buybacks, increased dividend, distribution deal with China Mobile (NYSE:CHL), and the entrance into a new category such as TVs, the trader in me wants to just isolate next week’s event.

While in some ways I would love to see the stock just completely fall out of bed, I think the greater likelihood is that much of the potential bad news from the earnings is priced into the stock at current levels.

I want to make a defined risk play that the stock bounces on better-than-expected results. Long premium structures on the whole look like a difficult way to make money as the implied volatility has been elevated for weeks now, and will most certainly see a substantial decline. In many ways, the best trade on the board is likely to sell volatility, but we will wait right before the event to identify the proper structure.

With little time left before Apple's earnings, I need to be cognizant of how I choose establish a long premium position. This is where butterflies come in. If I were back trading at a bank, I would likely choose to buy a 1×2 call spread or a call tree, but because I have to be cognizant of naked short positions and margin, I will look to cover my wings.

(I am putting this trade on very small, as I am reserving my right (so to speak) to change strikes closer to the print.)

Trade: AAPL (~$500) Bought the Jan 25th 525 / 550/ 575 Call Butterfly for 3.00

Bought one Jan 25th 525 call for 8.80.
Sold two Jan 25th 550 calls at 7.25 or 3.625 each.
Bought one Jan 25th 575 call for 1.45.

Break-Even on Jan25th Expiration:

Profits between 528 and 572 with max gain of 22.00 at 550.
Losses of up to 3.00 between 525 and 528 and between 572 and 575, with max loss of 3.00 below 525 and above 575.

Trade Rationale: I like the idea of isolating that 550 strike on the upside as I think the stock could struggle there as it has recently. This trade works well after the announcement on any move higher towards 525 and above, and has enough room to still stay profitable if AAPL surprises everyone and the stock makes a big upside move. If the selling pressure continued in the stock and we saw 400s after earnings, I’m only risking $3, something that was worth the shot.

This item by Dan Nathan was originally published on RiskReversal.com.

More from RiskReversal.com:

MorningWord 1/22/13: Implied Earnings Moves Trending

Macro Wrap – A Tale of Two Companies, $SLB, $JCI

Too Many Options – Usual Suspects, $AAPL, $BAC, $FB