OptionPundit

Tag: Call Option

  • Will You Trade Apple Earnings Like Warren Buffett Traded Burlington Northern?

    Apple (AAPL) is scheduled to report earnings on April 24th. I have already shared some interesting things about this quarter that you may want to read before playing Apple earnings (Please read to get on-board).

    So, assuming you want to trade AAPL earnings, you need to answer following (for this earning announcement only) –

    1. Are you Bullish?
    2. Are you Bearish? or
    3. Are you Neutral and don’t care whether Apple drops or goes up after earnings, but you still want to trade without a directional bias?
    4. How much will Apple move? Whether bullish, bearish or neutral, you need to decide how much Apple can move. For this article, I shall assume that Apple might move +/-$40 (this doesn’t mean that I think it will move by $40)

    Let’s discuss the the BULLISH case.

    This assumes that you are an Apple fan, you believe in the company and you want to add to your previous purchases. You are a long term investor. You are in no hurry though.

    You could do it via followings-

    1. Buy 100 Apple shares @ $573, your investment risk is $573×100= $57,300; If Apple goes up $40, you make 40×100=$4,000 i.e. $4,000/$57,300= +6.98%; if it drops $40, you lose $4,000 or -6.98%. But since you are a long term investor, you don’t really care for short-term “fluctuation” because you know Apple business is worth more than $573/share and you have enough margin of safety at $573.
    2. You can buy ITM, ATM or OTM weekly, next month, or LEAP call options to lower your cost. For simplicity, let’s assume purchase of only 1 contract of May’12 $500, $570 and $640 calls which costs $7,980, $3,120 and $865 respectively (as of Friday April 20, close). Assuming post earnings, Apple goes up $40 and IV drops by 10%, the $500 call be worth ~$12,000, $570 call will be ~$5,200 and $640 calls will be worth ~$1,500 (post earnings) and ~12,000, $4,300 and $0 respectively on May 18th expiration close. By playing via call options you are leveraging your capital. As you know leverage is a double edged sword. So, if Apple drops by $40, the leverage will work against your trade, incurring greater losses.

    There are many others option strategies to go long but for now let’s focus on these two popular ones. Clearly both the strategies have their own advantages and disadvantages.

    Here is the 3rd alternative, (more…)