Yesterday, we identified a nice opportunity for an AAPL earnings trade. We sold a strangle at the 570 and 650 strike prices, but the important decision was the choice of expiry series. We could have played the weekly series that expires today, but this would have exposed us to large losses if AAPL made a big move. Instead, we noticed that Implied Volatility had also spiked up in Nov1 weekly series to 47%, and decided to take advantage of this opportunistic situation.
This was a safer trade because of two reasons – 1) There is no reason why the Implied Volatility of this series should be this high when the steady state IV of all expiry series was around 35%. 2) If AAPL did make a big move, then we have time to adjust if necessary. Figure below shows what happened to Implied Volatilty this morning after the earnings event. It crashed to 31%. Amazingly, the Implied Volatility of this series is the lowest of them all. This makes sense because as you approach expiry, the effect of Implied Volatility decreases, and premium gets sucked out of Options.
As it turns out AAPL did not make a big move. And with Implied Volatility crashing from 47% to 31%, this trade has become very profitable. The same strangle that we sold for $11.3 yesterday is now going for $2 (see Figure below). That’s a return of 10% (on the margin amount) in 1 day, or 3650% annually. Of course, not every trade can work out so successfully, but the takeaway is to try and spot a pricing anomaly by looking at Implied Volatility of different series during earnings reports times. We all give too much credit to market makers. They are also human, and every now and then you can spot a pricing error in Options. Once you see it, you need to move in for the kill..I’m very satisfied with this trade, so may be closing this trade. Although, if I hold it until next Friday, we could pocket the balance 2K of profit left in this trade. Maybe I’ll hold it over the weekend and pocket some more time decay, and get another 1K profit on Monday or Tuesday, at which point I will close it out.
Please post your thoughts below on this trade or if you took any other trade on AAPL earnings. If you sold premium, you did well..