On Tuesday, my inbox was flooded after my last column, “Seven Reasons Not To Be Foolish Ahead Of Apple Earnings.” All of the emails were from readers who felt that they knew for sure what Apple was going to do after earnings.
About half of the email writers felt strongly that Apple would go up about $30 to $40 after the release; the other half felt that Apple would fall about $50 after the earnings call. These spreads were somewhat wider that what option premiums in Apple were indicating. Option premiums were indicating a move of about 7% after earnings, and that’s what the stock initially got.
There were three common elements in about two-thirds of the emails: these investors were trading options and not the stock, they asserted that I knew nothing, and that it was foolish on my part to write such a column. For an investor who was convinced of a $50 or 12.5% move, it made sense to buy options because the premiums were only about 7%. If the investor was right, the investor would have netted about 5%.
Here is the rub, if an investor turned out to be right, he would have made about 5% while risking about 7% by buying put or call options. Clearly this was not a favorable risk reward ratio unless there was data to show better than 70% probability of the move in the direction chosen by an investor.
One email writer bought both puts and calls predicting that he would make money if Apple earnings were good and he would make money if Apple earnings were bad. He stated it was like having his cake and eating it too… Read more at Forbes
