We're right in the thick of earnings season with results coming in daily for key companies in the S&P 500.
XWhile it can be a risky time for option traders, there is also a lot of opportunity.
One popular trade among option traders is a short straddle that is held over the earnings announcement. This is a risky trade because it involves the sale of naked options, so it is not recommended for beginners.
The losses are potentially unlimited so always keep that in mind.
Apple (AAPL) reports earnings on Wednesday after the closing bell so I thought it would be interesting to take a look at a short straddle using the Jan. 29 expiration.
To set up a short straddle, traders would sell the at-the-money call and the at-the-money put. AAPL stock closed at $142.92 on Monday, so the at-the-money strike would be at $143. At the close of trade yesterday, the $143 call was trading around $4.90 and the $143 put was trading for $4.95.
Selling these two options would generate $985 in premium with break-even points at $133.15 and $152.85 (the strike plus and minus the total premium).
Selling Straddles On AAPL Stock Is A Higher Risk Trade
Market makers set option prices based on an expected move over the life of an option. Currently the implied move for AAPL stock over earnings is around 6.89%.
This is calculated as the premium of $9.85 divided by the stock price of $142.92. It also means the stock can move up or down by 6.89% before the trade has losses at expiration.
After Apple's last earnings announcement, the stock moved -5.6%. There's no guarantee of course that the stock will stay within the expected move again this time.
Implied volatility is currently trading at 47%, much higher than the regular level seen for AAPL stock. In part this is because of the earnings announcement, as there is always a lot of uncertainty around how the numbers will come out.
Will AAPL stock stay within the expected move of 6.89% or will the move be bigger than that?
If the move is less than 6.89% the straddle sellers win. If the move is more than that, the straddle buyers win.
Selling straddles over earnings is a popular strategy for option traders, however it's important to be aware of the risks when trading naked options.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ
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AAPL Stock Short Straddle To Capture Volatility - Investor's Business Daily
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