In our quest to understand trading options for income, the topic of this article is trading Apple during earnings, when IV (implied volatility) is at its highest.
As mentioned in previous articles, when IV Percentile is above 50%, which occurs the day of earnings announcement (Apple announces after the Close), your POP (probability of success) increases as IV typically drops significantly after the announcement.
The advantage of trading options is the flexibility of selecting strategies to match your expectations. Since earnings causes the current front-weekly (or monthly) option chain IV to increase far beyond the average IV of other chains, we would want to select a selling premium strategy, like Strangles and Iron Condors (IC), to take advantage of this.
Why Apple? Apple is referred to as a jumbo stock, which means its price per share is expensive (currently around $550), and this translates into higher premium for the options (Call or Put) for a given POP (or level of risk); the lower the POP, the greater the premium.
Tasty Trade recently conducted an earnings test of Apple and four other jumbo stocks (NFLX, AMZN, GOOG, MA) over a two-year period using ICs. The combined results: NTM (near the money)= $1,726 (60.53%); 1 SD (standard deviation)= $580 (71.05%). The largest losses respectively were: -$271.50 and -$377.00. By comparing the P&L to the largest loss, we get the following ratios respectively: 635.7% ($1,726 / $271.50); 153.8% ($580 / $377).
At Options Annex we conducted a similar test for just Apple over a three-year period (2011-2013). Instead of using an IC, we decided to test a Strangle (which requires far more margin as an undefined risk strategy). We also wanted to test for the following levels of risk: NTM (POP= 50%); 1 SD (68%); and 1.5 SD (90%).
Incidentally, NTM is taking the short strikes for the Call and Put that are near the current price of the underlying asset, Apple.
What were the results (see the table above)? NTM= $4,976.90 (58.3%); 1 SD= $2,223.50 (91.7%); and 1.5 SD= $1,256.00 (91.7%). The max loss for each were, respectively: -$3,569.50; -$2,412.50; and -$795.00. And, comparing the P&L to the largest loss, respectively: 139.4%; 92.2%; and 158.0%.
Comparing Apple to the Tasty Trade results, we can see a NTM Strangle provides far more premium ($4,976.90 vs. $1,726) than a NTM IC, but at a greater max loss ($3,569.50 vs. $271.50). Keep in mind, this is the largest loss amongst the five stocks; and we assume that the spread for each leg of the IC is $5. Also, the total number of trades for Tasty Trade is 38 vs. 12 for our Apple test.
Comparing the NTM and 1 SD percent winners between Tasty Trade and Apple only, we find the following: NTM 60.53% vs. 58.3%; 1 SD 71.05% vs. 92.2%. The former is close (for both tests) to expectations of 50%; the latter reveals a big difference 71.05% vs. 91.7% when the expected rate is 68%. This reflects, in my opinion, that Apple has less outliers (better behaved) than the other jumbo stocks tested by Tasty Trade.
Another interesting result with our test is that the 1.5 SD level has a far lower max loss ($795 vs. $2,412.50) while the P&L was slightly more than half the 1 SD level. The 1.5 SD level also has the highest P&L/Max Loss Ratio at 158% amongst the three levels. This means that you can trade twice as many Strangles at 1.5 SD than the 1 SD, and receive more premium with a lower expected loss.
In conclusion, Apple is a well behaved asset very suitable for an earnings play. If you prefer a defined risk strategy, then use an IC; to get more premium with the IC, you can widen the strikes (from $5 to $20) and set your risk level at 1.5 SD.
If you would like to learn more about options, and how to easily generate consistent weekly income trading options, go to Options Annex.