Case Study $AAPL: Reducing Risk Using Options into Binary Events



Before I go any further (and if those words above doesn’t say it enough), I want to say that this isn’t a Monday Morning Quarterbacking play as AAPL had reported earnings earlier this afternoon.  Nor is this me gloating about an AAPL earnings miss.  I believe that a lot of traders choose to avoid options because the different strategies can be complicated.  I will agree with the previous statement but will add that there are simple structures or strategies that can be implemented to achieve directional objectives.

For this post, I will specifically talk about using options to reduce risk on profitable positions going into binary events.  For today’s example it is AAPL earnings report.


So here’s the scenario:  You bought 100 shares of AAPL stock back on October 10th for $385 as it crossed the 50 SMA (daily).  The stock is trading at roughly $422 today into earnings.  You are sitting on a $37.00/share UNREALIZED profit and although you’d like to take profits and buy back at key support levels like the 50 SMA (~$387), you’re hesitant to do so as you’d like to participate on any upside move to what you think could be $450(Cell A5) should it have positive numbers which is $28/share away (Cell A8).  So you find yourself in a a dilemma as you want to participate in any upside move although it can very well the be the case that the stock sells off and you give up a portion or at worse more than your unrealized profits.  As we saw with the AAPL earnings report, even the most beloved company can miss expectations and take a hit.


As you can see, by holding onto the stock, you can make an additional $2,800 profit should it go to $450.  However, we now know that if you held on, you would have given up a big portion of your unrealized gain from $3,700 to roughly $900 (Cell B11).


One way to have played the AAPL earnings using options would have been to lock up the $3,700 profit and using a portion of the profit, roughly $680 to play the upside by buying the October $425/$450 call vertical.  In addition, since you don’t mind owning it back again at $385 if gets back there, you can sell the naked $385 put for $90.  You’re maximum profit on the call spread should AAPL close at $450 or above in 3 days would be $1,820 (width of the spread minus $680 premium paid).  $3,700(locked stock profit)+$1,820(call spread profit)+$90(credit on sold put)=$5,610.  Compare this to just holding on to the stock which would bring you $6,500 ($385 to $450).  So this structure basically gives up about $890 in profit should the stock hit target of $450.  However, it does give you protection of a stock drop of $37.90/share to $384.10 (sold put less premium collected) before you start losing money.    Another way of looking at this is plugging in current price levels of $394 and seeing what the effect would be on your holding by holding onto stock (Cell B11) versus selling stock and playing the options structure mentioned above (Cell C11).  In essence you are giving up $890 in potential profit loss to protect $3,700 in realized profits.  Not a bad play isn’t it?

Before you get too excited there are some downsides and things to consider:

-Any pop above $450 and you start to leave more profits on the table.  You could opt to widen the call spread to cover moves to $455-$460 but it will cost more potentially reducing net profit if the price goes in the opposite direction as it did today.

-You won’t have the ability to trade AAPL immediately after it reports and before market opens

-Since there are 3 days left to OPEX, you will have to manage the structure for the remainder of the week.

Again, I didn’t write this blog to be a hindsight trade but for future reference when faced with a similar situation into binary events (earnings, FDA decisions, etc) that you as a trader can apply to your stock holdings.

If you have any questions you can find me in the room jgwilson929 or at twitter @jdub929.



Posted in Earnings, General Trading, Options