Is Apple a ‘Buy’ Ahead of Next Week’s Earnings?

Once a stock market darling, Apple (NASDAQ:AAPL) has fallen into an undeserved funk. Earnings are expected to be reported Tuesday after market close, and even though my proprietary earnings algorithm is forecasting a beat for the tech giant, the stock has a reputation for being unpredictable following its reports.

The good news is that with a little statistical analysis and the right strategy, we can greatly increase our chances of profiting from Apple’s post-earnings move — even if the stock doesn’t move higher.

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In fact, all AAPL has to do is stay above $107 and today’s trade will deliver a return of more than 15% in less than a month’s time.

Apple Skittish After Earnings

After kicking off 2015 with a 20% rally to its late-February highs, AAPL traded in a sideways pattern for most of the spring and summer, unable to break to new highs. 

During the late-September correction, shares fell below previous support and failed to bounce back. The stock now trades in a new channel with resistance around $117.

Despite posting record iPhone sales and beating analysts’ estimates on both the top and bottom line in the most recently reported quarter, Apple is 13% off its summer highs.

It now trades at just 11.8 times forward earnings with a PEG ratio of 0.72. As you can see in the chart below, these valuation metrics are approaching their lowest levels in a decade. 

AAPL Chart

Earlier this week, analysts at Piper Jaffray named Apple their top large-cap stock pick for the remainder of 2015 with a $172 target. Billionaire investor Carl Icahn believes shares should be trading for double what they are today. The average analyst target of $146 is more conservative but still 26% above recent prices.

This bullish sentiment seems more than justified with the record-setting launch of Apple’s new lineup of iPhones and successful introduction of Apple Music. The new streaming service already has 15 million users — 6.5 million paid customers and 8.5 million on a free three-month trial. So far, Apple Music is converting 60% of the trial users to paying customers. For some context, competitor Spotify only manages to convert about 26% of its users to subscription plans. This is yet another win for Apple.

With shares seemingly on sale, valuation metrics near a 10-year low and my earnings algorithm projecting a beat next week, it may seem like the perfect time to buy shares of Apple. 

But not so fast…

As I mentioned, Apple is known for its unpredictability after its earnings reports.

Bloomberg shows AAPL has made an average daily move of 4.4% following its earnings reports. But while the company has beaten expectations in each of the past four quarters, calling the direction of that move has been a crapshoot. 

However, deeper statistical analysis shows that in the past two years, 30 days after Apple reported earnings, shares were higher 75% of the time.

So even if AAPL moves lower following Tuesday’s report, it’s a relatively safe bet to assume it will recover within the next month.

Taking this into consideration, I have a trade that greatly increases our chances of success.

This trade will allow us to make money if Apple stays flat or goes higher. It fact, it could even be profitable if the stock falls. All AAPL has to do is remain above $107 — which is 7.4% below the recent price — through Nov. 20, and we will make a profit.

Make a Potential 15.1% on Apple in 28 Days

The strategy is known as a bull call spread, and it involves simultaneously buying one call option and selling another with the same expiration date but a higher strike price. The option premium from the call sold decreases the cost of buying the long call.

For this trade, I am interested in buying one AAPL Nov 102 Call and selling one AAPL Nov 107 Call for a net debit of $4.30 or less ($430 per pair of contracts).

Note: Be sure to use limit orders when entering and exiting a bull call spread to get the desired prices.

AAPL Trade Ticket

The most this trade can be worth is the difference in the strikes. This is achieved as long as AAPL stays above the strike of the short call ($107) through expiration in November.

Therefore, the maximum profit equals $5 ($107-$102) for a return of 16.3% over the $4.30 net debit paid to enter the trade.

However, I like to set my profit target slightly below the maximum profit to automate the trade and allow for an early exit if the stock continues to rally. When you enter the trade, place a good ’til canceled (GTC) limit order to sell (close) the spread at $4.95. This will result in a 15.1% profit in 28 days, or an annualized gain of 197%.

The breakeven for a bull call spread is the strike price of the long call ($102) plus the net debit paid ($4.30), or $106.30, which is 8% below AAPL’s current price.

If the stock is below this level on Nov. 20, we will experience a loss. But no matter how low AAPL goes, the maximum loss is limited to the amount paid to initiate the trade, or $4.30 in this case.

A bull call spread is the perfect strategy to reduce risk around earnings while still benefitting from potential strength in this best-in-breed tech company.

Recommended Trade Setup:

— Buy one AAPL Nov 102 Call
— Sell one AAPL Nov 107 Call
— Enter trade for a net debit of $4.30 or less
— Set GTC sell limit order at $4.95

Note: We hope you liked today’s trade from options expert Jared Levy. While it’s not the typical trade we’ve featured on Profitable Trading in the past, it’s an incredibly lucrative strategy that you’ll likely be seeing much more of in the future.

We’ve prepared a short fact sheet about Jared and how he has used options to become a millionaire several times over. It takes no more than a few minutes to read. Click here to access it.