For example, at-the-money straddles cost about $38.60 on Monday, implying that buyers were anticipating a move of over 6 percent post earnings - anything less 6 percent would have made the strategy a losing proposition. Expectations were for a price move of about 3 percent based on historic norms for Apple according to the research team at Sterne Agee and Leach amongst others.
Still, anticipating a big move in Apple post earnings but balking at the high premiums, the traders at Sterne Agee looked at the Powershares QQQ as a cheaper alternative. With Apple making up about 18 percent of the index, the QQQs are a good proxy for the tech giant, says Alex Panagiotidis, Managing Director in Institutional Equity.
In addition, its component names are part of the index and might be expected to move along with shares of Apple. The big difference is that the “weekly” QQQ options were trading at a steep discount in terms of volatility—roughly 26 percent versus 93 percent volatility for Apple’s “weekly” options. Lower volatility translates into cheaper premiums—and bigger potential profits.
Keeping in mind, this is a non-directional play – the investor makes money if the stock goes up or, if the stock goes down – the only risk is the premium paid.
“If Apple has a good number, the stock will explode and take tech with it,” says Panagiotidis. Conversely, a disappointing number could send the tech index sharply lower.
Sure enough, Apple topped earnings estimates and its stock soared more than 10 percent in trading the next day. Shares of the QQQ were higher as well but, by a smaller amount.
In either case, being long a straddle on the QQQs at a cheaper price could be a better alternative to buying expensive Apple premium that is decaying at a rapid pace.
But, that is not exactly how it worked out this time. Apple surprised to the upside, its stock posted its biggest one day price gain in the company’s history.
“Apple moved more than implied, more than median move, they blew it out basically,” says Panagiotidis. While still a winner, the long QQQ strategy underperformed the long Apple strategy – the QQQ straddle returned about 25 percent versus about 37 percent for the long AAPL straddle. In this case, lower risk equaled lower reward.
“Premise of the whole trade was to reduce your risk on apple,” added Panagiotis proving that there was more than one way to slice the trade on Apple.
Sterne Agee disclosure:
This message contains information and materials prepared by trading and sales personnel of Sterne Agee & Leach, Inc. ("Sterne Agee") and is not a product of Sterne Agee's Research Department. This message is for informational purposes only. It may be based on information obtained from other sources; however, Sterne Agee cannot guarantee the accuracy of such sources. This message is not an offer, recommendation, or solicitation to buy or sell any security, nor is it an official confirmation of terms. Sterne Agee and/or its affiliated companies, including their officers, directors, or employees, may have positions in any security discussed herein, and may, as principal or agent, buy or sell such securities, or may have served as underwriter with respect to such securities.
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