by Dan April 14, 2011 3:41 pm • Commentary

UPDATED April 14, 2011: Ten days ago I took another look at AAPL as Barron’s had just written a fairly rosey outlook for its near and long term prospects and I wanted to take the time to consider stock replacement strategies for long holders, or synthetic longs for those looking to initiate new bullish positions.

-Since April 4 the stock has been in a bit of a funk down ~3% vs the NDX down ~1.75%, while that doesn’t seem like massive under-performance when you consider that AAPL makes up about 20% of the index one could arrive at the conclusion that the stock acts very badly on a relative basis.  Which is probably what led the Index to announce that week (not specifically because of any near term relationship but the risk in the future) that in early May they will be lowering AAPL’s weight to ~12% (read here).


AAPL reports earnings and will give guidance, the first since Jobs’ latest announced medical leave on April 20th.

-The options market is implying about a 5% move, which is fairly rich to the 3.25% average over the last 8 qtrs.

– Nasdaq re-balancing to be completed on the close, May 2.

MY VIEW: these 2 events could cause divergent price action and actually cause the company to stray from their relatively common conservative guidance, especially at period when Jobs is not at the helm.  If this were to happen it could cause shorts to cover post earnings, but my sense would be that this would be met by selling either by indexers or those looking to play the re-balance.

-Technically the chart (see below) looks horrible and one worry I would have if I were long (which I am not) is that this is a very crowded trade…..a material breakdown below 330 could have the stock at a key support level of 320, and at that point all bets are off.

-My sense would be there could be a bit of some yoyo action: the company first tryign to put their best face on Jobs not being around and how that affects their guidance, the impending supply from indexers and then what I would expect the natural bounce from a month of selling pressure.

[caption id="attachment_1057" align="aligncenter" width="418" caption="1 Yr AAPL chart showing key support at ~320 LiveVol chart"][/caption]


Use APRIL 21st weekly Options to Express short term Bearish Views:

AAPL (stock ref 333) BUY THE APRIL 21st Weekly  320 / 310 Put Spread for ~1.80

-Buy Apr21 wkly 320 Put for 3.50 and

-Sell Apr21 wkly 310 Put at 1.70

Break-Evens on April21st weekly expiration:

Upside: stock btwn 318.20 and 320 lose up to 1.80, stock above 320 lose all 1.80 (less than 1% of the underlying).

Downside: Stock btwn 318.20 and 310 make up to 8.20 (or ~2.5%), Best Case, stock below 310 and make the full 8.20.

TRADE RATIONALE: I want to isolate the earnings event, while the weekly options are expensive I don’t really want to get whipsawed around all the re-balance goofiness….will play the earnings event and then look to re-initiate a short.  I also think the June time period going to be very important for AAPL as we should get further news about Job’s return and potentially new iPhone which may not come.

Original Post:

FROM APRIL 4, 2011:

Barron’s Fawning All Over AAPL….Again.  Consider Stock Replacement Strategies

For those of you who don’t trade for your profession or work in the securities industry then you don’t have the almost daily pleasure of listening to one of the 49 wall street analysts that have a BUY (there are only 5 holds and NO sells) on AAPL come up with new reasons to support their ratings and price target (which Bloomberg averages to be ~$437, or about 27% higher than current price of ~$344).

-But you are probably fortunate enough to listen to portfolio manager after portfolio manager go on CNBC (also daily) naming AAPL as their top pick and most favorite stock EVER.

-Well, Barron’s jumped on the bandwagon in this week’s edition, and while I may sound kind of cynical, they did a nice job of laying out some of the issues that face the company (and the stock) near term. I will summarize, but you can read here:

BULL CASE From TIERNAN RAY of Barron’s 4/2/11:

Valuation: backing out cash and marketable securities of $60 billion, or $64 per share, Apple shares aren’t just cheaper than the S&P, they’re bizarrely cheaper. It trades at 11 to 12 times this year’s projected earnings per share, versus the S&P’s average of 14 times, despite EPS growth projected at 52% this year by analysts.

Product Opportunities: the expectation for iPhone sales of perhaps 60 million to 70 million units this year doesn’t seem to fully reflect Apple’s opportunity. The stock  is up about 7% this year, just even with the Dow Jones Industrial Average—hardly what one would expect for a company that created a new market overnight, the tablet computer craze, with its iPad business expected by some to be worth $17 billion this year.

RAY: I WOULDN’T BET AGAINST APPLE on supply concerns alone. When one factors in the negative sentiment among some fund managers around Jobs’ hiatus, and worries about broader market factors, such as the end of the Federal Reserve’s quantitative easing this summer, there’s a passel of worries one has to look through.

OK we get it, AAPL is the cheapest and best stock ever, but if famed tech strategist Fred Hickey, “would neither short nor buy” AAPL, you may want to wait for a pull back to initiate a long position or to add.

NEAR-TERM BEAR CASE laid out by Fred Hickey, as quoted in Barron’s 4/2/11:

The disaster in Japan is one of the biggest challenges, of course, and Hickey says the implications for Apple, and indeed for all of tech, are deepening day by day. “I think at first people tried to shrug it off,” he says of supply-chain problems stemming from Japan. “We’re seeing just in the last 24 hours reports of motherboard prices rising, disk-drive prices going up.”

Despite Apple’s deep, deep pockets and its long-term supply agreements, Hickey doesn’t believe we can say for certain whether Apple’s margins will get hit by higher component prices. Nor can we say for certain that the company will get enough components to make enough iPads to meet raging demand.

Add to the mix rumors last week that Apple’s iPhone 5 may not ship this summer, as expected, but perhaps in the fall. Is that a result of component scarcity or a deliberate choice by Apple? “I think it’s going to take a couple of quarters for all this stuff to work itself out,” before Apple shares work again.

MY VIEW: Generally I have been a huge fan of the AAPL story, but for the last 6 or so months I have become increasingly worried about how one-sided it is in the investment community. On Feb 24th, 2011 I suggested a defensive structure against long positions when stock was about same spot ($344), read here.  Generally I think the company has hit an innovation wall for the near term, and one of the more important challenges facing the company is how to stem the cannibalization of mac’s from iPad (we have already seen this in iPod from iPhone) or maintain margins on iPad which will be very difficult to do given competition.

MY VIEW (from Feb 24, 2011): company and stock have had a hot streak of epic proportion, even the biggest cynics cant argue…..but let me take a quick shot. The stock primarily moves because of the next hot gizmo the company is rumored to grace the earth’s presence with. At this point i think it is safe to say that us mere earthlings who just meander around doing whatever it is we do in between iWhatever launches have a very good sense for what is coming between now and Summer; an updated iPad in Mar/Apr and and updated iPhone for AT&T, possibly a lower end version for the first time.  I guess even more important is my sense is that last years iPhone 4 launch was probably the last iPhone launch that Steve Jobs will be present for.  I take no pleasure in saying this, and have no facts to base this on other than rumors and press reports about Job’s deteriorating health,  But the company is not doing themselves any favors with investors by not officially naming a succession plan.

Lingering Near-Term Challenges:

-Innovation: I think the company has hit an innovation vacuum at time where their creative driving force is not likely to be nearly as impactful as he has been over the last 10 years….what else do they really have to create and tell us how much better our lives will be once we shell over the $$ to get it…..ok listen, i love their products, i probably have 20 of them in my house, but i am kind of at a saturation point and i feel like the company has had to get a bit more promotional in convincing us how great their products are…..last yr when Jobs introduced the iPad he called it magical and revolutionary, well a yr later i think most can agree it is neither and as my daughters like to call it a “ginormous iPhone that doesn’t make phone calls” 🙁    So they better figure out how to create a platform of phones or gains some serious market share in computers, because iPods are going the way of the dodo and it seems like every new computing product just canaalizes legacy products.

-Competition: Apple has become more and more dependant on iPhone and iPad for their continued success, more than 50% of the company’s revenues come from those 2 categories and it just so happens that mobile has been and continues to be one of the most competitive areas in tech with what seems like dozens of rivals always looking to undercut on price…..everyone is gunning for AAPL in mobile; MOT, NOK, MSFT, GOOG, HPQ (PALM), HTC, LG, Samsung, and even DELL….i say mobile because all of the guys in addition to competing on the smart-phone platform are in some way planning to compete in the tablet space.  Margins will erode and AAPL will be forced to deal with a lower margin structure as all of those listed above have had to do in pc’s and/or handsets prior to the emergence of smartphones and tablets.

-Oh did i mention that the purported i”Phone” doesn’t work as a phone?  At least that is the case on AT&T, and yes, I am beating a dead horse (actually no animals were harmed in any way in the making of this post), but it still doesn’t work and I don’t want to switch to Verizon because I want a ‘Phone” that works overseas and works while I am surfing the web (which the VZ versions does not). I have had every iPhone and have generally been very happy with everything other than the Phone part. And to be fair I buy it for all of the other stuff on it other than the “phone”.  But it would be nice if it works. Maybe they can get to that on the iPhone 5.

-Every large mutual fund and hedge fund couldn’t be longer this stock.  When you consider the strong potential for a product miss-execution or the even larger potential for Jobs not to rejoin AAPL due to health issues, you have a very crowded story with lots of very concentrated positions……

-Most AAPL watchers routinely say that the “Jobs thing” is discounted at this point in the stock. Well, let’s just see how calm everyone is when we finally get clarity…..

I get it,  you can’t NOT own the st0ck of a company like AAPL whose products, execution, market position, management and future prospects are so great because you fear for the health of its founder, but you have to recognize that as the stock continues to make new highs and as the expectations for new innovative products with flawless execution remain the same, that the margin for error becomes razor thin.

WAYS TO PLAY IF YOU HAVE TO BE LONG: I think you would have to be crazy to initiate new long positions in the name here and I am not going to go over Put Spread Collars for Long holders, but if this structure interests you, you may want to consider different strikes as it is a bit more expensive now, even with stock in same place….

-June/July time frame will be heavily influenced by news regarding the release of iPhone 5. The last 4 versions have been announced in early June (excluding the 1st) and released shortly after in late June to mid July.  The one thing that could change this time table, aside from the potential component shortages detailed in the Barron’s piece, would be AAPL’s decision to coordinate the launch of the iPhone 5 btwn AT&T and Verizon.  The problem here is that AT&T customers are due the refresh in June/July and Verizon customers have only been offered the product since early January 2011…..so the likelihood of AAPL offering Verizon customers iPhone 5 this summer is slim and in some ways impossible, they would have a massive Egypt-like revolt on their hands.


Please Login or create account to read trade ideas below:

1. TRADE BUY JUNE 360 /400 CALL SPREAD for ~$9.40

-Buy June 360 Call for ~11.80 and

-Sell June 400 Call at ~2.40

Break-Even at June Expiration:

Upside: btwn 369.40 and 400 make up to 30.60 (or 9%), above 400 make full 30.60.

Dowside: btwn 369.40 and 360 lose up to 9.40 (or ~3%), below 360 lose all 9.40.

TRADE RATIONALE: Define Risk, look to take the downside out of the equation, while 9.40 may seem like a lot of premium, the risk reward of paying out 3% to make 9% if the stock is up 16% seems kind of reasonable.  I say kind of because this is AAPL and if the company continues to execute and has at least the AT&T iPhone out this summer and possibly adds a new product and the market rally is intact, I would guess that $400 should be achievable by June expiration……But those are a lot of IFS, and that is why I want to define my risk.


2. BUY JUNE  310 / 370 Risk Reversal for ~.30

-Sell the June 310 Put ~6.60 and use the proceeds to

-Buy June 370 Call for ~6.90

Break-Evens on June Expiration:

Upside: stock 370.30 (up ~7.5%) or higher unlimited profits.

Downside: stock btwn 370 and 310 you lose .30 premium, Worst Case stock below 310 (down 10%) and you are put the stock .

TRADE RATIONALE: the Risk Reversal adds considerable risk to the trade vs the straight call spread purchase, but for those looking for a smaller premium outlay and possibly looking to buy AAPL on a dip, this could be the perfect structure to do so as the bands in which you get long are wide, but more importantly you get long up 7.5% vs getting long on the downside at 10%. Also if you are currently long, and considering stock replacement this structure is no riskier than owning stock, in a lot of ways gives you a bit more flexibility as you do have a little downside cushion.


-AAPL chart below shows a huge under-performance of the stock since the March 10 close prior to the earthquake in Japan.  I want to lean on names like this that haven’t confirmed the new highs (or almost new highs) in the major indexes.


-Additionally, when you take a slightly longer term view, the 6 month chart below shows that since making a new all time high in mid February, the stock has made 2 lower highs and 2 lower lows.  Next sell off in the name could easily take it down to 320.

6 month AAPL chart            Bloomberg Chart