Earlier this week, we outlined a potential options trade on Apple (AAPL) before earnings. That strategy hit maximum profit this morning after strong results sent the tech giant to a new all-time high.
Let’s take a look with TradeStation’s OptionStation Pro. The green arrow indicates the longer-dated calls we hypothetically owned, while red shows the contracts we “shorted.”
First, here’s how to calculate the value of the spread:
- Bid price of long contracts – Ask price of short contracts. (Yellow rectangles.)
- Remember, contracts you’re long are sold at the bid and contracts you’re short must be purchased at the ask.
- In this case the spread is worth $2.55 ($6.60 – $4.05), actually exceeding its $2.50 notional value.
Second, notice the price-change differential. (Blue rectangles.)
- The 3-August 195 calls “we sold” gained only $1.62 of price as AAPL shot higher.
- But the 10-August 192.50s “we own” gained $2.55 of price.
- This is the real magic of the diagonal spread: It profits from different rates of price change in two different options.
Third, notice the destruction of extrinsic value, or time value.
- In Monday’s premarket, the 3-August 195 calls had $2.14 of time value. This morning it was $0.73, and will continue to crumble into expiration on Friday. (Red rectangle.)
- Remember that our mocked-up trade was short that time value, so profited from the decline.
Going forward, we have “options” on what to do next:
- The strategy could simply be closed for $2.55, or a 62 percent profit based on the $1.57 entry.
- If we do nothing this week, the 3-August 195s would be exercised and make us short stock at $195 next week. (This would be hedged with no upside risk thanks to owning the 10-August 192.50 calls.)
- We could pay $4.05 to buy back the 3-August 195 calls and have unlimited upside potential through August 10.
- We could sell the 10-August 195 calls for $4.70 and pay $4.05 to buy back to the 3-August 195s. In that case we would receieve a net $0.65 and still have the potential to collect $2.50 more if the stock remains above $195 on August 10.
AAPL is currently up 4.2 percent to $198.26 in morning trading, and is more than 1 percent above its previous all time high. Investors found a lot to like in the quarterly numbers, with the tech giant’s established handset business bolstered by higher iPhone pricing. Meanwhile newer activities — services and wearables — showed positive traction.