Name That Trade – Bobbing for $AAPL

by Dan October 17, 2014 1:39 pm • Commentary

Apple (AAPL) reports its fiscal Q4 results after the close on Monday. The options market is implying about a 3.5% one day move and weekly move of about 4.5%* which is shy of the 4 & 8 quarter averages of about 5%.

*The implied move can be figured out by taking the cost of the weekly at the money straddle (the sum of the Put and Call of the same strike in the same expiration) and dividing by the stock price.  At the moment, with AAPL at $98, the Oct 24th weekly 98 call is offered at $2.25, and the Oct 24th weekly 98 put $2.25.  If you bought the straddle for $4.50, you would need a $4.50 / ~4.5% move in either direction (above $102.50, or below $93.50) to break-even.

Yesterday prior to AAPL’s iPad launch event, I closed a near term bearish trade on AAPL.  The original thesis was that the current stock price reflected a good bit of the enthusiasm associated with the launch of the new iPhones.  Despite making a new all time high in early September, the stock has made a series of lower highs and lower lows, but nothing particularly extraordinary in either direction and has remained in a fairly tight range.  From the stock’s high on Sept 3rd to Wednesday’s two month low just above $95, the stock sold off about 8%, a tad less than the 10% sell off in the S&P 500 and the Nasdaq Composite from their Sept highs.

$95 is becoming an increasingly important near term technical support level:

AAPL ytd chart from Bloomberg
AAPL ytd chart from Bloomberg

I think it is safe to say that Apple investors kept their cool at the heights of the last week’s sell off.  Given the company’s balance sheet with nearly 30% of their market cap in cash, and their near 2% dividend yieled and the iPhone upgrade cycle just kicking in, investors view it as defensive, and seem to feel comfortable owning it at 13x next year’s expected earnings.

Regular readers know where I stand on the quality of that earnings number given their massive share buybacks, low tax rate and the fact that earnings are expected to be the same as the end of fiscal Q4 2012 in the fiscal year just ended. From my Sept 3rd note One More Thing On $AAPL’s Ability to Deliver on High Expectations:

Earnings about the same, sales up 15%, gross margins down 5% points, cash balance up 36%, and the introduction of debt to the balance sheet.  The balance sheet management is stellar, the company has paid almost $20 billion in dividends (many would argue given their cash flow they could pay out much more), and bought back between $50 and $60 billion in stock in that time period.  So what I want to focus on is the NET INCOME figure that has declined 7% in that same time period.  While earnings look flat, the company has retired ton of shares having a massive positive effect on their earnings PER share (eps), but in my mind leaving the decline in NET INCOME to stick out like a sore thumb.


So the stock is cheap(er) ex-cash than in 2012, but now trades at a market multiple of about 16x trailing earnings, and one could argue that all that cash on AAPL’s balance sheet should not trade at anywhere close to a market multiple and that without massive new product categories double digit sales growth will be difficult to come by off of such a large base and the cash will be needed to manage anything near double digit EPS growth for years to come.

At this point, I suspect the quarter just finished (fiscal Q4) to be inline to possibly disappointing as consumers waited for iPhone and iPad refreshes that they knew were coming in Sept and Oct.  On the flip side, fiscal Q1, the current quarter to be reported in January, should be huge given the success of the iPhone 6 and 6 Plus sales in the U.S. and the rumored pre-orders in China.  But here is the thing, that should all be IN the stock at the present moment.

For weeks into the iPhone launch I was very vocal on my distaste for the positive SENTIMENT on the stock, and to be fair, my negativity has subsided a bit as the relative performance in the last couple weeks was kind of impressive.  Here is the thing – the stock’s reaction to Monday’s earnings will be the real TELL and will likely dictate how the stock trades into year end.  If market volatility were to come back, anywhere near what we have seen over the last 2 weeks, Apple as a massive outperformer, up 22% year to date, could see profit taking as the overall market breadth has gotten very poor into year end.

For those who are long AAPL shares and are looking for some near term protection into Monday’s potentially volatile earnings events, weekly puts look dollar cheap, ESPECIALLY given the recent bout of market volatility:


AAPL Long stock $98.00: buy Oct 24th weekly 96 put for 1.40 as hedge

Protection below 94.60


Gains of stock above 99.40, long put strike plus current stock price (1.40 plus 98.00)

Losses of up to 1.40 between 94.60 and 96, max loss of 1.40 above 96, so you are paying 1.4%

Rationale:  If you are only worried about the possibility of a big decline on earnings next week, but still want the potential upside on good news, then this simple put protection makes sense.  It is not advisable if you don’t expect a big move on earnings.  Rather, given the recent market volatility, this trade is for those who are nervous about their position, but want to hold the stock into the earnings event. If you wanted to spread this option on any weakness and sort of lock in a 10% or so correction protection, selling the 88’s near here or even the 87’s lower makes sense to reduce hedging cost and that’s likely the area where AAPL would first see significant support on a selloff.