Max Grigoryev
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Max Grigoryev in Fundamentality,

AAP: Two Opposite Options Strategies

Advanced Auto Parts is the largest retailer of automotive replacement parts and accessories in the United States. They are going to report their earnings tomorrow morning, so we need to decide whether we can play out ahead of earnings or just simply avoid. We've seen quite a significant volatility during the previous week - Valeant impressed everybody with better than expected results, as well as Macy's and JWN. AAP stock fluctuated less than 5% after two previous earnings announcements, however, the stock plummeted more than 15% after Q3'15 results. 

Analysts are mostly positive about AAP, 7 'buy' and 6 'outperform' recommendations with 14 'hold' and no lower recommendations. The company's revenue is slowly going down, those analysts forecast 6% decline on y-o-y basis:

While AAP's EPS is expected to go down even more - around 6.6%:

Source: Financial Times

As you can see, in most cases the company reported almost inline with analysts range, however a small miss in revenue resulted in 15% fall. It doesn't seem that market is waiting for some volatility here, that's why I think that the best strategy would be selling the strangle. I'd better take on the minimum risk here and sell two OTM call and put options. The initial outlay could be the following:

As I've already mentioned, it's not the most profitable strategy - your maximum return would be $33 or the premiums you can get for both options. However, the risk is also limited. If the stock stays within $141-$189 range, you get your $33 return. It means that the stock could go up 12% or down 16% and you still make money here. If you think that the stock could go up more than 7% or down more than 5%, you can definitely buy a straddle. It would be more risky, but your return could be higher as well. In this case, I suggest buying 170 call and put options:

In this case your P&L table in dollar value would be the following:


As you can see, your maximum return is almost 30x times higher if the stock's volatility jumps tomorrow. Which strategy you want to choose depends on your portfolio and your vision. It also depends on how much risk you are ready to take on.