Apple options became way too pricey ahead of earnings this week, sending traders looking for alternatives.
The big demand for Apple options, both puts and calls, was due to fears of a big stock move post earnings. That pushed implied volatility up to levels that made buying short-dated options too expensive and made instruments like options on the QQQs ETF more appealing.
Media and market speculation built for days ahead of the report, creating an unusually high percentage of Apple options to trade. A lot of the speculation was negative, suggesting Apple could have a big miss.
That demand helped push short term volatility north of 90 percent, driving up premiums that attracted traders willing to sell short-term volatility and manage the risk but making buyers, pause.
About 9.3 percent of all equity options traded on exchanges Monday was in options on shares of Apple.
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.
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