How Time Was Money on Tech Earnings: Winning Trade in Apple

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Earlier this week, we outlined a potential options trade on Apple (AAPL) before earnings. That strategy hit maximum profit this morning after strong results sent the tech giant to a new all-time high.

Let’s take a look with TradeStation’s OptionStation Pro. The green arrow indicates the longer-dated calls we hypothetically owned, while red shows the contracts we “shorted.”

Apple (AAPL) options chain with the August 3 & 10 expirations. Short contracts in red, long in green. Price change in blue.

First, here’s how to calculate the value of the spread:

  • Bid price of long contracts – Ask price of short contracts. (Yellow rectangles.)
  • Remember, contracts you’re long are sold at the bid and contracts you’re short must be purchased at the ask.
  • In this case the spread is worth $2.55 ($6.60 – $4.05), actually exceeding its $2.50 notional value.

Second, notice the price-change differential. (Blue rectangles.)

  • The 3-August 195 calls “we sold” gained only $1.62 of price as AAPL shot higher.
  • But the 10-August 192.50s “we own” gained $2.55 of price.
  • This is the real magic of the diagonal spread: It profits from different rates of price change in two different options.

Third, notice the destruction of extrinsic value, or time value.

  • In Monday’s premarket, the 3-August 195 calls had $2.14 of time value. This morning it was $0.73, and will continue to crumble into expiration on Friday. (Red rectangle.)
  • Remember that our mocked-up trade was short that time value, so profited from the decline.

Going forward, we have “options” on what to do next:

  • The strategy could simply be closed for $2.55, or a 62 percent profit based on the $1.57 entry.
  • If we do nothing this week, the 3-August 195s would be exercised and make us short stock at $195 next week. (This would be hedged with no upside risk thanks to owning the 10-August 192.50 calls.)
  • We could pay $4.05 to buy back the 3-August 195 calls and have unlimited upside potential through August 10.
  • We could sell the 10-August 195 calls for $4.70 and pay $4.05 to buy back to the 3-August 195s. In that case we would receieve a net $0.65 and still have the potential to collect $2.50 more if the stock remains above $195 on August 10.

AAPL is currently up 4.2 percent to $198.26 in morning trading, and is more than 1 percent above its previous all time high. Investors found a lot to like in the quarterly numbers, with the tech giant’s established handset business bolstered by higher iPhone pricing. Meanwhile newer activities — services and wearables — showed positive traction.

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David Russell is VP of Content Strategy at TradeStation. Drawing on nearly two decades of experience as a financial journalist and analyst, his background includes equities, emerging markets, fixed-income and derivatives. He previously worked at Bloomberg News, CNBC and E*TRADE Financial. Russell systematically reviews countless global financial headlines and indicators in search of broad tradable trends that present opportunities repeatedly over time. Customers can expect him to keep them appraised of sector leadership, relative strength and the big stories – especially those overlooked by other commentators. He’s also a big fan of generating leverage with options to limit capital at risk.