With Apple Investors Worried, Pre-Earnings Option Pricing Looks Like an Opportunity

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With Apple’s quarterly earnings report just around the corner, prices for the stock’s options are being pushed upward by a spike in implied volatility far above historical levels. For investors who would be willing to buy Apple anyway, naked put writing provides an opportunity to profit from the inevitable fall in implied volatility once the results are in.

With Apple (AAPL) bouncing around the mid-390s today, May puts at the $390 strike are going for more than $18.

High levels of uncertainty and investor worry about the pending quarterly report have pushed implied volatility in the options to above 80% — well above historic volatility in the 30s. In other words, demand is so high for the option to sell Apple at a price of $390 that investors are willing to pay $18 for that protection — yielding a net selling price of just $372.

For investors willing to own Apple anyway at a price of $372, the pre-earnings spike in volatility presents an opportunity: write the May put while its value is inflated by abnormally heightened levels of investor anxiety, and either close the position when volatility falls after the report, or buy the stock at a discount should it close at any level above $372 and below $390 at May expiry just a few weeks from now. Should the stock rally significantly after results, the value of the short put will be reduced more quickly, as both the change in the underlying stock and the change in implied volatility combine to shrink it (where the former goes by the Greek name of delta, and the latter by vega).

Note that the shape of the profit/loss curve for naked put writing is identical to that of covered call writing; in both cases, if the stock rallies more than the amount of the option premium, profit on an absolute basis would have been greater with the unhedged approach of simply buying the common stock.

However, with a naked put’s standard margin requirement of 20% of the underlying stock, plus the put’s premium, plus the amount by which the option is in-the-money, this approach requires collateral of roughly $9200, as compared to the $39,500 or so which would be required simply to buy the stock outright.

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