Trade Idea: JPMorgan: Buy Apple calls before earnings

By Doris Frankel

Investors who agree with J.P.Morgan's equity analyst view that the stock should lift higher over the coming days should consider buying those August calls, they wrote in a report.

Apple, the world's largest technology company by market value, is slated to release fiscal third-quarter results after the stock market close on Tuesday.

This trade can be entered for a net cost of $13.15 based on Friday's stock closing price of $364.92. The break-even of the call trade is $378.15. Buyers of equity calls, which convey the right to buy the company's shares at a fixed price up to a certain date, risk losing the premium paid if shares are below the strike price of the call option at expiration.

"Our call is that the wow factor, i.e., extraordinary upside to consensus estimates, is about to return to the model," said J.P.Morgan IT Hardware Equity Analyst Mark Moskowitz. "We think this dynamic should lift the stock higher in coming days."

Moskowitz repeated an overweight rating on Apple and set a December 2012 price target of $450 unchanged from the December 2011 target in a separate report on July 14.

Some investors are holding out for a monstrous second half when the new iPhone hits and a new online content service takes wing. For details, see [ID:nN1E76C1A7]. Apple has beaten Wall Street estimates for 13 straight quarters.

The strategists estimate Apple options imply a 2 percent earnings related swing for the stock compared to a 4.5 percent move in either direction over the past ten quarters.

"This disconnect between the implied move and realized move makes buying calls attractive, in our view," they said.

Furthermore, the strategists said over the past ten quarters, the stock has had a positive move 80 percent of the time with an average move of 5.1 percent.

Apple's one-month implied volatility, a barometer of anxiety, stood at 29 percent, which is currently in its 30th percentile over the same time period.

Although the stock has realized volatility of 24 percent over the past month, the strategists believe realized volatility should pick up when earnings are released.

With Apple shares trading at $368.86, the August $365 call is now $3.86 in-the-money. So far, 8,332 August $365 strike calls changed hands by Monday afternoon against open interest of 38,924, Reuters data shows. Apple's most active option is the August $370 call, carrying volume of 18,061 contracts.

In all, about 233,000 calls and 135,000 puts traded so far in Apple, according to option analytics firm Trade Alert.

(Reporting by Doris Frankel; Editing by Andrew Hay)