Sunday, January 17, 2016

AAPL 2016 Update #63

Friday was a very volatile day in the markets. All the major US indices were weak and closed significantly down, although off their lows.  AAPL surprisingly has been holding up well and closed the week at 97.13

Volatility is now rising a little more, meaning fear is really starting to come into the market. On the whole AAPL volatility is up with the near term 7-30d options closing in on 42%

Specifically, as before there is a earnings event coming up for Apple on Jan 26 (options expire week of Jan 29).

Tactically, I have a Jan 29' 95 Put in place holding the floor the position over the earnings event. The downside is covered.

The question what about the upside? What are the prospects of AAPL skyrocketing? Should I stay uncovered until after earnings or is there an opportunity before to sell premium (and purchase more stock)?

To give a little more insight we can look at some probabilities. 

Two things are guiding this stock collar on AAPL -- one is the chart specifically supply and demand zones and the other is a statistical method. Given the steep declines in AAPL, we can assume there are trapped longs (want to be sellers) above current price. That alone will cause price to reverse any upward biases until that supply is exhausted.

I can also look at what the option market is telling, particular as we get into the last week before the earnings report. The option market can give an idea to a expected move range which has a probability of 68% containing the price range. That means, given enough earnings events, over time price will fall within this range 68% of the time given the current level of volatility. Typically this earnings expected move gets more accurate the closer to the event as the market reaches more of an expected consensus on price.

Does this mean it will absolutely happen this way? No, of course not. It all depends on the number of buyers and sellers than ultimately move into the market based on the earnings outcome. But the option market is quite accurate and represents real dollars buying and selling.

So how do we figure this out?

We can use the expected move formula (EM). Earnings is in 11 days and the implied volatility for that options series containing the earnings event is 42%. Without going into the details of the calculation (I have another blog post about that), here is a summary of the data:

Expected Move Summary

The lower range and upper range are the 1 standard deviation interval for price over the next 11 days. This is a 68% probability of price falling within this range. 

What this tells me is that the 105 strike price has a about a 70% chance of containing all possible moves. It does not mean that it will, just that there is a better than average (50% chance) probability of price staying below this strike.

Another way to calculate the move is to look the at the ATM (at the money) options for the underlying over the expiration cycle.  For AAPL, the current option chain is pricing the following:

ATM Option Chain
The mid-price for the call and the put are trading at 3.75 (call) and 3.68 (put). This is for the Jan 29' expiration. They are pretty much evenly priced indicating little to no skew in the market. This may change over the next week, but it also indicates that the market has probably now priced in all conditions.

Add the two option prices up which gives 7.43. This is close to the calculated move above. In actuality, this method works best the day before earnings and is multiplied by a factor of 0.85. Option prices will get bid up this week positions are taken. I would expect this value to increase yet again as IV increases right up to the event.

The range of expected prices is 97 +/- 7.43, which again places the higher end about 104.43. This is close to the 105.65 value.

Aggregately, these moves are between 7.6 and 8.7 percent moves of the price of the stock. 

Don't forget, upon earnings, the price could actually move 0 pts, price remains within the expected range and IV will collapse. Those betting on the 8% move would not make anything, up or down.

Interestingly, on the 1 hour time frame there is a supply zone just above a pivot high 105.78

What actions can I take?

Okay, so now we have an upper range to work with. Is there a trade or adjustment to be made? There are actually many. It all comes down to how much risk you want or don't want and the profit potential.

Here is one example.

The current short call @ 102 is expiring Jan 22'. It has less than 0.30 of value (and will probably be less when the markets reopen on Tuesday). IV is also high for the following week. This is an ideal time to sell an option -- high IV that will absolutely crush once the earnings are out.

The 102 short call can be rolled forward and up in time to the 104 for around a 0.90 net credit. That credit can then be used to purchase more stock, around 8-9 shares worth.

If this trade were taken on Tuesday, the resulting position risk curve would look as follows:

We would be carrying about 816 shares worth of stock, with a net downside of about -$122 and potential profit of just over +7K.

Time will tell what price the stock actually settles at on expiration, and in fact it could do absolutely nothing. In the meantime I can once again define my risk and accumulate more stock and prepare for the next move in price.

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