All eyes will be on Apple (NASDAQ:AAPL) tomorrow after the market closes, as the Mac maker is scheduled to release one of its most important earnings reports in years. Naturally, investors are anxious to know not only what kind of digits the company will put up, but also how shares will react following said figures. What does the options market think Apple will do after it reports?
As I've outlined previously, going long options heading into earnings isn't as cut and dry as some investors may think, since options market makers begin to factor in increased implied volatility, or IV, into option prices ahead of earnings. Higher IV levels represent higher options prices, and tomorrow's earnings release for Apple is no different. The options market has been pricing in a big move, as you can see in the rising brown line shown below.
How does that increase in IV translate for investors? By looking at the prices of options that expire weekly, investor can get better insight into what kind of move the market is pricing in. In order to gauge the expected near-term move, you can look to the price of an at-the-money straddle with very little time to expiration. Doing so allows you to reduce the amount of intrinsic value within the option's price, and looking at contracts that expire this week mean the market is expecting these moves to take place immediately after earnings.
With Apple closing at $504.77 today, let's look at the $505 strike. The asking price on a $505 call that expires this week is currently $17.55, while the asking price on a $505 put with the same expiration is $17.75. That means an investor would have to pay approximately $35.30 to buy both a call and a put, creating a long straddle.
Straddles are popular strategies among options traders who are looking to bet on volatility. Instead of betting which way the stock will move, they bet that it will move by at least a certain amount. In this case, for a long straddle to pay off, Apple would need to move by at least $35.30 either up or down in order for the trade to be profitable, representing a 7% move.
For better or for worse, the options market is pricing in expectations that Apple will be trading near either $540 or $470 by week's end after the iPhone maker reports earnings.
Fool contributor Evan Niu, CFA, owns shares of Apple. The Motley Fool recommends and owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.