Tuesday, April 26, 2016

AAPL 2016 Update #86 (Earnings Release)

AAPL releases earnings after the market close today (AMC). The consensus is that sales will be dropping for the first in a very long time. AAPL price wise has declined significantly since last week, now nearly 6pts off its previous swing high (112 to 104.50).

Earnings releases are a crapshoot and the price can move either way, sometimes quite drastically. If there is a gap down or gap up in pricing that can make adjustments hard to manage once the move has happened.

The position is quite well hedged with just the short 105 call and is hedged at least to 50 delta. Because the price has been moving down in orderly 1pt to 1.5pt steps, it has been easy to just roll the down the calls to follow the price move capture close to 50% of each drop in price.

Earnings releases can be more unpredictable.  Let's look at some measurements that we can get from the options price data and the price action on the chart.  After that I can look at an options move that will protect capital in case something really unexpected happens to the downside.

Option Pricing for the Earnings Move (Binary Event)

There is a way to estimate a 68% chance (1 SD price move) for the move of stock price during earnings. The easy way to estimate this price range (+/-) is to look the at the money (ATM) options during the week or earnings. This weekly series priced the day before or day of earnings has the consensus built in expectations for earnings by positions that are hedged in the market.

From previous posts, I have shown how to estimate this range. It involves taking the ATM values of the both the puts and calls, adding them together, and multiplying by 0.85.  That number is the plus or minus move for the stock within about a 68% probability.  That also means, there is a 30% chance it could move outside that range.

For AAPL the chain data is below. The move is roughly +/- 4.00 with the stock sitting near the 105 strike. (2.09 + 2.59) * 0.85 = 3.97

That means there is a 68% chance that price after earnings will range from 101 to 109

Price Support

Let's look at price chart. There is now an obvious supply zone that I have marked high on the curve. Price has moved away very strongly from the 112 level. The question now is where will demand pick up and buyers step in.

There are two places -- both potentially lower. There is a gap just above 102. Gaps represent extreme demand and the origin of that gap is a good place where buyers can step in. That range is from 100 to 101.96.

The second and better (lower priced) demand zone is the start of a strong daily candle from 95.21 to 97.50. This range is the origin of the recent strong move upward. I would mark this as being lower on the demand - supply curve or range.

Depending on the ER news and how its interpreted these are the lower end ranges I would need to keep a watch on.

Fig 1 - Price action day of earnings (Apr 2016)

Play Defense

Part of trading is being defensive and maintaining capital. What could happen (and most likely will) is that price just move slightly, 1pt or 2pts either way from the 104-105 range. If that happens the position value will fluctuate a little, and there may be an opportunity to roll the calls either up or down.

If the stock jumps to the upside, the position will remain profitable and the either I roll the calls up or let the position get carried away and start over again. I will take what I can get and move on with a new trade.

If however, the stock collapses further, that could be a more of a problem. If its a small drop that can be compensated by rolling the calls down. If its a larger drop of 5pts to 7pts, the move in price won't be fully compensated by rolling down the short calls -- the price gap is too large and too sudden. If there is a real collapse in price, I would want to have puts in place to create a floor on the position.

The problem is that puts (insurance) cost money (debit) and it where will it come from? The answer is by selling call premium.

The short calls are still out 1 week in time. They still have time value. Earnings is going to be released in hours, all I need is insurance for a few days until the storm settles.


Part 1 - Roll the calls and collect some premium (Note: I could have also extended duration roll out in time to get premium, but if this position is going to be assigned, I don't want to wait long)

+8c May W1 105 Calls @ 2.30
 -8c May W1 104 Calls @ 2.80
Net debit: -0.50/c

This gives me 0.50 to go and purchase insurance. With that 0.50 I can buy the 98.5 puts expiring in 3 days. This is 1pt higher than the lowest demand zone (good to be above a lower price) but below the 101 demand zone.

Ideally, I would want to have puts (insurance) at a higher strike price. However that costs more money which I don't have to spend, so this is the best I can do.

Part 2 - Purchase protective puts (3d to expiry)
+8c Apr W5 98.5 Puts @ 0.48
Net debit: 0.48/c

Total position change is done for a net credit of 0.02/c X 8 = $16  (enough to pay for the commission on this adjustment with the broker).

What does the risk graph look like? This position graph looks a little funny because of the two different expirations. The long puts with shorter days to expiration creates a funny bend in the overall graph. After the puts either expire worthless or get sold because they go in the money, the curve will become cleaner again.

The main point is that the position has no downside risk. If the price suddenly drops, there will be a profit loss that I will once again adjust, but the stock can fall all the way into the 90s and lower without losing any of the original capital.

What will happen after ER? Will these puts go out worthless? I expect really not much to happen, just a fizzle. But from experience sometimes the unexpected happens.

I will post a update after hours today.

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