Fri Oct 12, 2007: Option Plays for GOOG and AAPL Earnings

Google announces earnings this Thursday October 18th, one day before October options expire. Apple announces earnings Monday October 22nd, after October options expire.

Chart of GOOG Stock   Option Prices for GOOG

Chart of AAPL Stock   Option Prices for AAPL

Both stocks are in powerful uptrends with high expectations for another round of strong reported earnings, so let's consider bullish strategies first.

For GOOG, the cost of buying 100 shares of stock at the current price of 637.39 is $63,739. On margin with 50% down it would be $31,869.50. An October 600 call option could be purchased for only $4,340 which is a premium of only $6.01 per share, not bad considering the stock has been moving as much as $30 per day lately.

For this option to double the stock would have to pop up to about 686 after the earnings report. Assuming that happens, selling the option would provide over $4,000 profit. At that point a quick and aggressive option trader might re-invest some of their profits to buy at-the-money puts, anticipating a profit-taking price decline. Such October puts on Friday, with less than a day left to expire, might cost around $1,000 each at that time. A $20 pullback could then provide another double-your-money profit.

Another, more patient, bullish approach would be to sell naked puts before the earnings are released, hoping for an immediate gain if the response is positive and the stock rallies, but if by some surprise the stock goes down at least it could potentially be purchased at a significant discount to the current price. For example, an October 620 put could be sold now for $1,020 and would expire completely worthless on Friday if GOOG just stays above 620 at the close. If not, and you let the put be assigned, your purchase price would be effectively 609.80, at least better than buying at the current price of 637.39. This assumes you have money set aside in your account to purchase the stock. The same approach with a November 590 put at $1,100 could eventually provide a net cost of 579 for the patient option writer (or simply a one-month profit of $1,100 if GOOG is above 590 on November 16th).

For AAPL, call option buying is more expensive because the November options still have more than a full month of time premium on them (Octobers expire before the AAPL announcement). Instead of buying calls, selling put spreads might offer a better risk/reward play, with a more likely and reasonable profit, although more patience is required.

For example, a patiently bullish option writer could pocket a 22% one-month return by selling the November 145 puts for income and buying the November 140 puts to hedge, forming a bull credit put spread. As long as AAPL closes above 145 on November 16th, it's a full win.

Even higher put credit spread returns can be had by risking closer to the money. Note in the above table that as you move down the table (up in strike price, closer to the money) the percentage yield increases dramatically.

Also note in the table below that to achieve such percentage returns from naked put writing is much more difficult. Even selling an in-the-money (ouch!) November 175 put yields a paltry return (unchanged price assumption, time premium only) of just 4.9%, hardly worth the effort for sophisticated traders such as ourselves. Thus you can see the tremendous advantage of spread trading. Of course, the percentages shown in the table below assume paying 100% for the stock. In a margin account the yields would be double assuming a 50% down purchase. Even them, the returns pale by comparison to spread writing.

Now let's turn our attention to the (unlikely) possibility that the party is over for both GOOG and AAPL.

Bears hoping for a "sell-on-the-news" opportunity are fighting the uptrends in these stocks. Expecting the uptrends to actually end now, and the stocks to begin bear declines, is a low probability approach. The only sensible bear approach is to hope for a short-term correction.

For GOOG, this might mean gambling on buying October puts or writing October calls prior to earnings, hoping to make a quick score on a temporary pullback before the prevailing uptrend resumes.

For AAPL, buying (November) puts would be more expensive because of the extra time premium. Writing calls, conversely, would offer more premium income. But if and when a profit-taking decline does happen, the smart option writer might decide to buy back those calls to lock in a partial profit prior to November expiration, before AAPL fires up yet another rally.

No tree grows to the sky. The GOOG and AAPL uptrends will come to an end someday. But until then, the odds favor playing the uptrend, for all but the bravest and quickest option traders.

Until next time, best of luck with your option investments!