It’s tough holding stocks though earnings. And it’s downright reckless to establish new positions just before earnings. There is however a strategy we like to employ right after earnings. It’s called the credit spread.
We only employ this strategy after a strong earnings report and a big run up in the price that holds into the late morning / early afternoon. That of course is exactly what Apple did today.
After the 8%+ run-up in price this morning, the initial sell off, support and the run up in price I went to work to find a trade. After some research I discovered that Apple’s expected move into this Friday’s close was $6.00 dollars. The stock was trading around $567 at the time of my research. That means that the market makers expect apple to go down to $561 or up to $573. Since I’m bullish in Apple after the report and it didn’t sell off at the open, I went hunting for a put-credit spread.
The most advantageous spread I could find was the 560/555 put spread. By advantageous I’m referencing expected move, stocks direction, standard deviation distribution, and time and credit. Notice I said credit last.
Always shop your stock first, then the credit. Do not look for the options with the highest premiums or spreads. You’re looking for a combination of the least amount of risk with the most amount of reward. Armed with the spread, I wanted my partner at Noram Asset Management, Danny Stewart, to confirm what I saw and execute the trade for the firm’s clients.
Danny and I were able to obtain a .35-cent credit for this trade. That means we were paid .35 cents per contract. Since options trade in contracts that represent 100-share blocks this means a spread on 10 contracts, for example, that we took in $350 dollars as a credit. If you sell 100 contracts, you would bring in $3,500. We have already booked the credit and these weekly options expire tomorrow, so we only have to be right for a day!
Still not sold? Well, if we do this small style trade repeatedly on two stocks every week the money adds up fairly quickly. For me this trade is like shampooing… I want to rinse and repeat each week.
There is risk with this trade. Apple could close tomorrow below $560. We’d then lose the credit we took in plus the difference in the spread. If Apple were to fall tomorrow we’ll exit the trade for a small gain or scratch trade instead of absorbing a loss.
So what’s the upside and why accept .35 cents as a credit. The expected move was $6.00 at the start of the trade. At the close of trade Apple was trading at $667.77. Tomorrow Apple will have to lose $6.78 for this trade to fail. Here’s what you need to know. Apple at these levels has a 85.82% chance of closing above $560 tomorrow. Plus, I’m only holding this trade for a potential 8 hours max. The full trading day tomorrow and time left in the trading day when we executed. I like my odds of success. Plus, as mentioned above we’ll close the trade if there is peril in the markets tomorrow.
Always keep in mind – this is an income trade. Every week we generate income for clients in the most conservative manner. This isn’t a trade to swing for the fences. It’s a compliment to our directional investing.
I hope this explanation was helpful. Please do let me know.
If you have any questions or if you’d like to learn how we could assist you with this strategy please email me – Tim.Reazor@NorAmAsset.com
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