NEW YORK (TheStreet) -- Earnings season is a crazy time for any company, but what impact will earnings have on Apple this week? If you're nervously awaiting results of iProduct sales, maybe it's time to assess hedging strategies to help you sleep at night.
To be sure, all eyes on Wall Street will focus on the earnings report. But it will not be the earnings per share that will drive share prices higher or lower. The key metrics that big money will focus on are gross and net margins. Don't be surprised if earnings per share takes a backseat.
For more information about my thoughts Apple's earnings see this article: Be Greedy for Apple While Others Tremble.
Bearish pundits are calling for shrinking margins, and some analysts believe Apple is on an irreversible course of lower margins and commoditized products. The bear thesis ignores the profitability and market dominance that Apple enjoys, and the bears have successfully convinced the rest of the market that Apple shares are for losers and that if you don't sell now, you will have to liquidate at a lower price soon.
Unlike with Research In Motion
Well, maybe we can blame short-sellers for not shorting more shares, which may have helped support Apple while it declined. Even after the epic drop in share price, Apple doesn't have a lot of short interest.
Short-sellers receive a lot of unjustified criticism, but Apple is a good example of what happens when a stock doesn't have the stability and reduced volatility that short-sellers create. Fortunately for investors, Apple's volatility is a tool you can use for profit.
Russell Rhoads is an expert on exploiting market volatility and literally wrote the book on volatility. It's titled Trading VIX Derivatives: Trading and Hedging Strategies Using VIX Futures, Options, and Exchange Traded Notes. If you want to learn how volatility may help your portfolio, I'd strongly recommend you it.
Although it may not appear that a book about trading VIX futures is relevant for Apple investors, the volatility concepts are the same. As an Apple investor, you can use your Apple shares to hedge selling Apple volatility.
When it comes to selling volatility, the primary strategy of choice is selling covered calls. Call options transfer risk from one party to another. Stock options tend to have elevated premium into earnings. In part because of its high stock price, Apple tends to have premiums elevated enough that even when option buyers get it right, and the stock moves in their direction, they still have difficulty profiting.
The reason why option buyers have the worst of it is because short-term options immediately before an earnings announcement have premium decay that is on par with a snowball in hell. Simply stated, for option buyers, it isn't enough to get the direction right. In order to be profitable, the move must be extreme enough (i.e., beyond what the market is pricing in as a possible reaction) to overcome the high premium. That's not a barrier option buyers easily overcome.
Here are a couple of examples of call options I would consider selling into earnings if I owned Apple.
- April weekly (expires April 26) $420 for $4.60 or higher
- May weekly (expires May 3) $435 for $3.45 or higher
What happens if Apple screams higher and you don't want your shares called away? Simple, as the expiration date approaches, buy to cover the calls at the market value if they have moved into the money. We're not looking for a "sure thing" (only Washington insiders have that advantage), but if we can put the odds in our favor and have an advantage over time, the math says we will take a step towards maximizing our portfolio performance.
At the time of publication, Weinstein had no positions in stocks mentioned.
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
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