New Trade July 24th, 2012 at 1:45pm: Ok so here is the deal, as mentioned below in our preview from this morning, options pricing does not seem that out of whack heading into tonight’s print, especially the July weeklies, they look kind of dollar cheap to us. SO if you have a strong directional bias, these could serve as a decent way to express your view. For a lot of the reasons we stated below, we don’t have a strong directional bias, even with the stock up close to 50% ytd and only 5.5% from the all time highs. It is our view that a lot of things are going to have to go wrong at the same time for a company that has been executing near flawlessly for the stock to have a massive out-sized move to the downside. Don’t get me wrong, we are not bullish, but we like the idea of playing for either no move, or a 5-7% move to the downside with no premium out-lay.
As a trader, I want to play the quarter, and we looked a lot of different ways to do it, and there are very few that made sense to us without making an outright directional bet that has the characteristics of being a tad binary…..so here is the one that we all liked the best taking advantage of what we think is overly inflated downside vol in Aug.
MY TRADE: AAPL ($601) Bought the Aug 540 / 520 1×2 Put Spread for a .55 Credit
- Bought 1 Aug 540 Put for 4.11
- Sold 2 Aug 520 Puts at 2.32
Break-Even on Aug Expiration:
Profits btwn 540 and 520, make up to 20.55, with max gain at 520 of 20.55, payoff trails off btwn 520 and 499.45, above 540 make .55
Losses-below 520 you are put the stock on expiration but you have gains from the Aug 540 Put that you are long plus the .55 credit, so you effectively don’t have losses until 499.45 or down about 17%.
Trade Rationale: While there is plenty of risk to this trade as you are not absolutely defining your risk, there is a relatively high probability that you will make a little money, a decent probability that you can actually make money on 5% move lower in the stock and small probability that you could make a great deal on a 10% move lower.
This is not a pound the table bearish bet by any means, and in some ways if the stock gapped down $100 following earnings it would be the sort of gap that would surely be bought (barring some fraud or something) and would likely find a home somewhere btwn 500 and 550.
There is definitely margin implications for a trade like this on a high dollar stock like AAPL, so sizing is imperative, when figure out how to size I needed to calculate how many shares I would actually be willing to buy at $520 (but really $500, cause if the stock is down there I would have the $20 gain from the Aug 540 Put I am long).
One more thing, to avoid some of the margin issues I considered buying a Aug 480 Put and create a Put Fly and thus mitigate my tail risk. But Buying that further downside Put has trade offs, it would make the trade cost something and thus turning my Ratio Spread into a lotto ticket.
Original Post July 24th, 2012 at 10:31am:
Event: AAPL will report their fiscal Q3 earnings after the bell tonight. The options market is implying about a 5.5% one day move following the event which is a tad shy of the average move over the previous 4 qtrs of ~5.8%, but well above the 8 qtr average of 3.7%.
My View: For those of you who read my MorningWord this am, I am clearly less inclined to be bearish on AAPL for the sake of being contrarian as it appears that at least in the financial press and among investors, the fever has broken a bit. While the stock has been consolidating since its parabolic rise into early April, it by no means signals that risk has abated. We all know the bull story, the fabulous products with low penetration in massive markets like China, trading at a rock bottom valuation relative to its expected growth, with a balance sheet stronger than most Sovereign nations. Check, check, check annnd check. Got it.
So the real question for investors who want to be long AAPL for the next $600, is whether or not to do so, just 5.5% from the all time highs in front of a quarterly report that most bullish analysts have already previewed to possibly show some softness relative to their estimates based on push out of demand in front of iPhone5 launch in Sept/Oct. The bulls have already set up for near-term disappointment, but remember those analysts just have ratings and price targets on the stock that they rarely change, you have your life savings in it, or your kids’ college fund….the stakes are much higher for you.
Just as China demand for iPhone/iPad was the cause for massive out-performance in their fiscal Q2 reported in April, the temperance, or deceleration of that demand could serve as a near-term roadblock especially when you consider what other U.S. multinationals have had to say about slightly softening demand in the region.
If the stock sells off because of expected weak guidance only as a result of weak iPhone guidance for fiscal Q3, it will be bought in front of iPhone5. If it sells off because New iPad was weak in Q3, in its debut quarter, and Mac trends appear soft, then that is another story, because we could see a bit of an air pocket across the entire product portfolio into iPhone launch. And if the company speaks to any softening in big growth areas like China, we could see a sustained sell off. I don’t place a high likelihood on all of those things happening at once, so I think we likely see the weak revenues for Q3 that have been highlighted by some analysts, better than expected eps on soft component pricing and their usual tight cost controls and then we see their normal conservative guidance (see Piper comment below).
Stay Tuned for Our Trades.
Sentiment: Wall Street Analysts are overwhelmingly positive on the stock with 49 Buys, 5 Holds and only 1 Sell, with an average 12 month price target of about $735, or about 21% higher than current levels. Short interest is just 1.33% of the float. EPS estimates have remained flat over the last month, while revenue estimates have come in a tad, (less than 1% per Bloomberg data).
Estimates / Guidance from Bloomberg:
- 3Q EPS est. $10.39 (range $9.45-$12.51; avg. est. little changed over past four weeks)
- 3Q rev. est. $37.31b (range $34.54b-$41.73b; avg. est. down 0.6% over past four weeks)
- 3Q gross margin est. 43.7% (range 41.5%-45.1%)
- 3Q iPhone unit est. 28.4m (range 25.4m-30.9m, 19 ests.)
- 3Q iPad unit est. 15.4m (range 12.7m-18.5m, 19 ests.)
- 3Q Mac unit est. 4.3m (range 4m-4.6m, 17 ests.
- 3Q iPod unit est. 6.6m (5.9m-7.3m, 15 ests.)
- 4Q EPS est. $10.29 (range $9.18-$12.53; avg. est. down 0.8% over past four wks)
- 4Q rev. est. $38.05b (range $34.18b-$44.15b; avg. est. down 1.4% over past four wks)
- 4Q gross margin est. 42.9% (range 41.3%-44.3%)
Piper Jaffray analyst Gene Munster had the following to say about guidance in a note to clients yesterday:
Assuming Apple guides the September quarter consistent with past guides since 2006 (2% downside to revenue & 9% downside to EPS) implies $36.3b and $8.97 EPS (Street $37.1b & $9.86 EPS for June). However, we expect a more conservative guide than usual because of our belief that the iPhone 5 will launch in October, while the Street has mixed expectations in terms of timing.
Technicals: From Enis’ Chart of the Day
Over the last 3 years, AAPL has been in a pattern of breakout, consolidation, breakout, consolidation, and so on. I’ve highlighted the breakouts with a green box, and the consolidation with a red box:
The consolidation periods (ranging from 4-7 months) have been longer than the breakout periods (ranging from 1-3 months). During the consolidation period, the stock has rarely traded below the highs of the previous consolidation period. And the current breakout has been the strongest, trading further from the highs of the previous consolidation period than any other breakout. If this pattern holds, then AAPL probably has a few more months of consolidation ahead of it.
The size and speed of the most recent breakout are a bit of cause for concern on a longer-term basis, though AAPL has been an exceptional stock for many years, so it might continue to be the exception. From 2009 to the start of 2012, AAPL traded in a very orderly up channel, as shown here:
I actually view it as positive that AAPL has held above the breakout of the trend channel for a few months now. If the high in April was an emotional top, you would usually see the stock quickly sell off back into the channel (like GOOG in 2007 or GLD in 2011). The ability to hold the breakout in AAPL, even after a parabolic move, shows that there are still incremental buyers.
Finally, the 1 year chart basically shows the extremely strong momentum of the up move from Jan-Mar (high RSI circled with an oval):
The past few months are working off that overbought condition, but still holding above the 100 and 200 day moving average over that entire period. It’s another picture of consolidation. The charts show a neutral stance for AAPL within a longer-term uptrend, and I might play for continued near-term consolidation with an options trade today.
Here’s the 30 Day Implied and Historical vols graphed with the yearly average for both historical and implied volatility: (Red IV30, Blue HV30, Yellow IV360, Pink HV360)
What you’ll notice is that implied vol can range anywhere from the low 30’s to the high 40’s across all months going into its earnings events. There doesn’t seem to be a consistent pattern on whether that was dependent on how volatile the stock itself was going into that event, as the implied vol and actual vol have moved both in unison and separately into the events. What has been consistent is that following the events, implied vol tends to settle back in the mid 20’s.
Analyst Previews: Here are a few that I thought were pretty thorough:
Goldman Sachs-Buy /12 mth px tgt $850/July 18th, 2012:
We believe the iPhone 5 will be launched on time for the all-important December quarter, and we continue to believe the typical pre-launch pause in demand will depress legacy iPhone sales before then. While we are modestly raising our overall June quarter estimates, there are some moving parts to our forecast: we are slightly lowering iPhone unit expectations, raising iPhone ASPs, raising iPad units, and lowering Macs. We now expect June quarter revenues of $35.54 billion and EPS of $9.98 versus our prior estimate of $35.15 billion and $9.94. Consensus currently stands at $37.33 billion and $10.38. Our conservatism on legacy iPhone sales extends into the September quarter but is followed by an above-consensus December quarter as iPhone 5 shipments ramp. We also raise estimates for FY2013 andFY2014 on our optimism for iPhone/iPad trends and Apple’s competitive momentum.
Despite our near-term conservatism on iPhone units, we suspect the window for the bears is limited by the imminent iPhone 5 product cycle. In addition, we believe buy-side expectations for iPhone units are already very conservative for the quarter (26-27 million units) relative to our 28 million unit estimate, and most investors appear to be less focused on this short-term demand pause and increasingly focused on the iPhone 5 ramp. We would be aggressive buyers of Apple’s stock at current levels, and we reiterate our CL-Buy and 12-month target price of $850.
Morgan Stanley-Buy/Best Idea /12 mth px tgt $738 /July 17th, 2012:
AAPL is a top pick for C2H12. Although consensus C2Q12 and C3Q12 estimates may not fully reflect iPhone demand risk ahead of the iPhone 5 launch, investors are well aware of this timing issue. We expect positive data points around a new iPhone and potential iPad Mini to drive the stock near-term.
Our C2Q12 revenue and EPS estimates are 6% and 9% lower than consensus, as we believe sell-side estimates of high-20M iPhones and mid-4M Macs do not appropriately reflect shipment seasonality before the product refreshes.
We model 27M iPhones, 16M iPads, 4.1M Macs and 5.9M iPods, resulting in revenue of $35.1B, GM of 43.1% and EPS of $9.45. Gross margin upside could offset shipment risk resulting in EPS closer to consensus.
We see two points of GM upside to our and consensus estimate of roughly 43%, assuming iPhone GM improves one point due to component cost declines late in the product cycle and iPad GM declines two points due to the iPad 2 price drop. This implies a 3.5-point beat against Apple’s GM guidance, which is in line with historical average. The GM upside could boost EPS to $10+ on our shipment numbers, more in-line with current consensus of $10.38. We expect conservative C3Q12 guidance.
C2Q12 Revenue and EPS Estimates Apple’s earnings guidance, 10-Q disclosures and supply chain data points suggest sell-side estimates may be too high in C2Q, as they do not appropriately reflect shipment seasonality before the product refreshes. Although our C2Q and C3Q estimates are lower than consensus, our CY12 revenue and EPS estimates of $171.6B and $50 are actually slightly higher than consensus, as we model a stronger C4Q driven by the next-generation iPhone and potentially an iPad Mini heading into the holiday season.
Apple’s June quarter guidance of $34B in revenue and $8.68 in EPS, provided on the last earnings call, were 9% and 12% below consensus at the time. Since 2008, Apple on average guided C2Q revenue and EPS 2% and 10% below consensus at the time of guidance. Since the US recession officially ended in June 2009, there were only two quarters where Apple guided both revenue and EPS below consensus more than historical averages. The first time was the September 2011 quarter, when management correctly anticipated that consumers would wait for the then new iPhone 4S, and the second time is this June quarter – also ahead of a new iPhone launch.
Piper Jaffray-Buy /12 mth px tgt $910/July 16th, 2012:
We believe investors should own AAPL going into the June quarter earnings as we expect the company to report iPhone units better than low expectations of the buy side. We believe that generally investors are expecting 25-27 million units in the June quarter, but we believe the number could be closer to 28-29 million.
From a bigger picture standpoint, the June iPhone number isn’t likely to matter much as we believe that September expectations for iPhone are likely to be reset following the June report as we move toward the expected October iPhone 5 release. We reiterate our Overweight and $910 target.
Bogey For June Results & September Guide. For upside consistent with the last four years (6% upside to revenue, 16% upside to EPS), Apple will have to report June revenue of $39.65b and EPS of $12.05. We believe given mix shift away from the iPhone its unlikely that Apple will report EPS of $12.05 or better. Assuming Apple guides the September quarter consistent with past guides since 2006 (2% downside to revenue & 9% downside to EPS) implies $36.3b and $8.97 EPS (Street $37.1b & $9.86 EPS for June). However, we expect a more conservative guide than usual because of our belief that the iPhone 5 will launch in October, while the Street has mixed expectations in terms of timing.
iPhone: (50% of sales) Expect 28-29m Units And September Reset. We expect 28-29m iPhones in June, ahead of buy side expectations of 25-27m. We remain confident that iPhone units could be better than the Street given industry discussions around sustained weakness at RIM and Nokia in the June quarter, but we do not believe smartphone sales have slowed significantly, suggesting market share shift to Apple and Samsung. Beyond June, we believe the Street will reset September iPhone expectations ahead of the iPhone 5 launch. We are reducing our September iPhone number to 24 million from 26 million to account for consumers waiting for the next iPhone.
iPad: (24% of sales) Expect 16m iPads In Jun. Quarter. We expect 16m iPads in June, which we believe is roughly in-line with Street and buy side expectations. We note the iPad is the toughest of the three product lines on which to get a read. We are comfortable with our 16m expectation (up 73% y/y) given that it is a meaningful stepdown from previous iPad growth rates. We note that iPad units have been up an average of 153% y/y over the past four quarters. We note that iPads have remained in stock over the past several weeks on the Apple Store, suggesting supply is meeting demand.
CreditSuisse-Buy /12 mth px tgt $750/July 13th, 2012:
Results on 24th July, reiterate Outperform. For F3Q12, we expect revenue/ EPS of $37.4bn (-5% qoq/+31% yoy)/$10.15 vs. consensus at $37.3bn/$10.33. We expect group GM of 42.4% for the quarter, though better than expected iPhone mix could drive upside to our estimate. Our FY12/FY13 EPS estimates stand at $46.27/$56.75. Given our view that Apple is well positioned to maintain momentum across key product lines driven by continued innovation in hardware, software and services, we reiterate our Outperform rating and TP of $750.
iPhone building toward strong C4Q12. We recently reduced our iPhone estimates to reflect increased carrier discipline on smartphone subsidies in the US. Our iPhone volume estimate for F3Q12 stands at 28.5mn units (-19% qoq/+40% yoy) and we see the potential for slight upside in the quarter. However, given low smartphone penetration, carriers’ inability to ‘collude’ for a sustained period of time, and the roll out of LTE/4G technology, we believe that these pressures on iPhone volumes may be a short term phenomenon. We forecast 26.5mn units (-7% qoq/+55% yoy) in F4Q12 followed by a stronger than seasonal 50.3mn units (+90% qoq/+36% yoy) in F1Q13 (calendar Q4) buoyed by the iPhone 5 launch which we expect in late September/early October. For CY12/CY13, we forecast 140mn/187mn iPhone units which implies global smartphone market share of 21%/22% respectively (up from 19% share in 2011).
iPad room for upside; continued strength in 2012. In the first full quarter of sales of the new iPad, we view our forecast of 14.7mn units (+25% qoq/+60% yoy) as achievable in the current environment. Amongst an increasingly competitive landscape, we forecast Apple’s tablet share dropping from 62% in CY11 to 50% long-term, though this may prove conservative given company’s compute advantage and aggressive pricing (something we discussed in detail in our note ‘Compute Market Update – Raising estimates, tablets driving growth’ dated 10 July 2012).
Valuation remains attractive. Trading on a P/E of 10.1x our CY13 EPS estimate of $59.15, valuation remains attractive given earnings CAGR of 30% between CY11-13E, LT EPS power of $75, and net cash of $117/sh.