How a $0.67 Drop in Apple's Price Crushed These Investors

A couple weeks ago, Apple (NASDAQ: AAPL  ) stepped up to the earnings plate to take a swing with its fiscal second quarter report. The Mac maker unveiled modest figures alongside an impressive new capital return program. Including extended-hours trading, shares were all over the board between the market close on April 23 and open on April 24.

The volatility showed that investors were still trying to digest all the new information, particularly with regards to the $50 billion boost in share repurchases and the fact that Apple would fund those buybacks with debt. After everything was said and done, shares closed down just $0.67 per share the following day. That's just a 0.2% decline on a stock trading above $400.

Apple's very much a battleground stock these days, with optimistic bulls and skeptical bears continuously debating the iPhone maker's future. You'd think that a $0.67 drop wouldn't mean much to anyone, bull or bear. You'd be wrong.

There's a specific group of investors that got crushed from that pocket-change change: options investors.

It worked last time
The options market values volatility more than anything else and option investors factor implied volatility, or IV, into the market heading into known volatility events (such as earnings). You can get a sense for what type of a move that the options market is expecting by looking at pricing data.

For example, heading into the January earnings release, near-term straddle pricing suggested that the options market was expecting a 7% move (up or down) following the results. That time around, shares ended up plunging 12% so the bet would have paid off handsomely, since that strategy needed a 7% pop or plunge to break even.

Heading into the release last month, the same methodology showed that the options market was again pricing in a 7% move. Instead, Apple moved just 0.2%. Any options investors holding near-term options, either calls or puts, saw prices drop precipitously the next day. The reason is that once the news hits, IV drops and brings down all prices with it.

Source: CBOE. Emphasis added.

The brown line above shows the drop in IV that option investors were facing after earnings.

This unique aspect of options pricing is why I've always considered long options the worst way to play earnings announcements. Having long options heading into earnings is a concerted bet that the directional move will outweigh the loss of IV. In this case, there was effectively no directional move, and IV hurts on the way down.

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