AAPL earnings trade

[fradav 1]

Anyone any thoughts on the following AAPL earnings trade. It's basically an ATM calendar hedging  a weekly far OTM strangle adapted for holding through an earnings report

 

 

(1) Buy 10 x Oct 425 calls for approx 20 k debit (another back month may be more optimal)

(2) Sell 10 x Jul weekly 425 calls for 10k credit

(3) Using 18% of credit received from short calls, buy 5 x weekly 400/450 strangle. The strangle is positioned both on the edge of the profit curve for the calendar, which is alos of course around the outer strike at which options pricing are predicting for a post-earnings move.

 

Outcomes:

 

If the reponse to earnings is flat the calendar earns and covers loss on strangle.

 

If the response is extreme, the strangle covers loss to both upside and downside on calendar.

 

Important points/caveats: The stangle should ideally be sold as soon as possible post-earnings when wildest swing occurs, unless game-changing info is announced that will drag stock way beyond what option pricing is predicting (i.e., > $20 move)

 

There's also some 'weak' spots where there is break-even points and potential losses. Would need to spend time trying to tweak strikes to minimise them

 

It does require some guessing as to when to close the positions, and is best suited to either a big move post earnings (good for strangle) followed by a return to the norm (good for calendar) or a flat response with no swing. The worst is a flat response in first few days (strangle loses) followed by a big movement, eg 425 Wed and Thu then jump to 450 Friday.

 

There are of course a huge amount of variations on this play using puts instead of calls and strike prices.

 

I realise every possible trade combo has been tried out long ago, including this, but according to my trade calc this trade stands a pretty decent chance of success. Any thoughts/catches much appreciated.

 

N.B. It's likely that there will be a loss on the strangle, it's more insurance. However, every once in a while it could be a home run, something I've experienced from the wrong side of the trade.

Edited July 23, 2013 by fradav

[Kim 7,497]

Did you account for IV decrease of October options? Assuming 3% decrease, the trade will lose money anywhere between 400 and 450 next day after earnings. Holding longer might be profitable between 415 and 435 but lose around 440-460. With some maneuvering and some cooperation from the stock, it might end up profitable, but I'm not sure the risk/reward is favorable. 

[fradav 1]

Thanks for that Kim. My trade calcs don't take in the drop in volatility so no. Would it be better choosing a back month closer to Julywk4 where there's a greater drop in IV but less debit, like Aug monthly? Or less drop in IV but more debit (like Jan)?

 

I'd be planning on closing out the position on Friday if the calendar spread is in the profit range.

Edited July 23, 2013 by fradav

[Kim 7,497]

I would probably go with August. And maybe instead of 1:2 ratio, try 1:5 ratio, I think the P/L chart looks better.