Name That Trade(s) – Bobbing for $AAPL

by Dan October 27, 2015 10:35 am • Commentary

Earlier I previewed Apple’s (AAPL) fiscal Q4 results due out after the close (read below).  We now want to offer a few trade ideas using options as overlays to an existing position, or to express a directional view:  


1) Yield Enhancement Against Long Stock – Overwrite:

AAPL ($116) – Against 100 shares, Sell 1 Nov 125 call at $1.20

  • Profits, below $125 receive $1.20 on Nov expiration or 1% of the stock price
  • Stock called away at $125 if at or above that level on Nov expiration, but effectively selling stock at $126.20, up 8.8% in a month.

Rationale: this adds around 1% of yield but of course you are at risk of giving up your stock on a gap higher and must be willing to do that.


2) Protection Against Long Stock – Collar:

AAPL ($116) Against 100 shares, Sell 1 Nov 125 call at $1.20, Buy 1 Nov 104 Put for $1.20

  • Profits of stock up to $125, stock called away at or above.
  • Protection below $104

Rationale: this collar is for those willing to give up some upside potential in order to have disaster protection just above huge technical support at $100 over the next month.


3) Long Stock Alternative – Defined Risk

AAPL ($116) In place of 100 shares, Buy 1 Oct 30th weekly 116/126/135 Call Butterfly for 2.80

Break-Even on Oct 30th weekly expiration:

  • Profits: Between $118.80 and $132.20 make up to $7.20, with max gain of $7.20 at $126
  • Losses: up to $2.80 between $116 and $118.80 & between $132.20 and $135 with max loss of $2.80 below $116 or above $135

Rationale: This trade structure is in the money and risks 2.4% to possibly make up to 6% over the next 3 trading days with a wide range of potential profitability to the upside. This trade also attempts to offset the expected vol crush after earnings.


4. Stock Alt/Replacement – Bullish Risk Reversal (with downside risk)

AAPL ($116) In place of 100 shares, Buy Nov 105 / 124 Risk Reversal for even money

  • Sell 1 Nov 105 put at 1.45
  • Buy 1 Nov 124 call for 1.45

Break-Even on Nov Expiration:

  • Profits: above $124
  • Losses: below 105, between 105 and 124 no losses or gains, but prior to expiration will have mark to market losses as stock moves towards short put strike, and gains as moves closer to long call strike.

Rationale: This trade looks past the potential for short term movement post earnings and considers a run into the holiday selling season. Rather than spending a lot of premium, this trade creates a wide band where the trader could be put the stock on the downside, above key technical support at $100 as identified below in my preview and just above the breakdown level from early August. This is for those looking to catch a breakout in AAPL where they would participate like stock but are unsure about exact entry here into the earnings event. If the stock does pullback in the near term this trade acts better than simply being long stock on the downside. If the stock continues to trade in a range this trade is no harm no foul.


5. Bearish – Dollar Cheap weekly puts

 AAPL ($116) Buy the Oct 30th weekly 115 / 105 put spread for 2.60

  • Profits: between 112.40 and 105 make up to 7.40 with max gain of 7.40 at 105 or lower
  • Losses: of up to 2.60 between 112.40 and 115 with max loss of 2.60 above 115

Rationale: options prices are not exactly cheap heading into the print, but for those who are considering directional plays it makes sense to spread long options.


$AAPL Fiscal Q4 Earnings Preview

Event: Apple (AAPL) reports fiscal Q4 results tonight after the close. The options market is implying about about a 6.5% one day move, which is greater than the implied move prior to their Q3 report of 5%, that subsequently saw a post earnings decline of 4.25%.  The average move over the last 4 qtrs has been about 3.5%, while the 10 year average has been just a tad shy of 5% a quarter.

Sentiment: Despite the stock’s 12% decline since their fiscal Q3 report on July 21st, Wall Street analysts remain very bullish on the shares with 46 Buys ratings (an increase of 6 since late July), 8 Holds (a decrease of 5 since late July) and only 2 Sells (no change) with an average 12 month price target of about $148 (down about $1), or about 28% higher than current levels. Short interest is about 1.9% of the float nearing a high for 2015.

Price Action / Technicals:  AAPL is up about 4.5% on the year, down about 14% from its all time highs made in late April following its fiscal Q2 results, and up about 25% from its flash crash low on Aug 24th.

The one year chart below shows the apparent triple top that occurred in the low $130s, the first test of the prior high coming the day of the company’s Q2 earnings in late April, and then a third attempt on July 21st prior to the company’s Q3 results (both circled):

AAPL 1yr chart from Bloomberg

The stock last week bounced off of technical support at $110 (green line), but below that there appears to be little support until $100 (yellow line).

Taking a longer term view, the $100 level becomes that much more important, as it was the high in 2012, which preceded a 45% decline to its lows in mid 2013.  The stock is now sitting on the uptrend from the 2013 double bottom low:

AAPL 7 year chart from Bloomberg

Options Open Interest and Vol Snapshot:  Total options open interest is nearing the one year low, and down nearly 25% from mid August suggesting a slight lack of interest since the stock found its footing following the August 24th flash crash and has spent the better part of the last couple months straddling $110.

AAPL options open interest from Bloomberg

The top 10 largest strikes of open interest are all calls, with the largest 176k of the Jan16 140 calls, then 144k of the Jan16 120 calls, 135k of the Jan16 130 calls, and then 122k of the Jan16 115 calls.

As for options prices, they seem fair for the event, given the massive one day post earnings moves we saw last week in AMZN, GOOGL and MSFT, and the fact that the stock has had two 30% moves so far on the year in two consecutive periods (lower July to August and higher August to Oct).  The implied move looks fair, meaning reasonable, probably a better buy than a sale.

Fundamentals: I am going to reiterate some thoughts I had in a post from September 29th, AAPL Turnover, where I touched on what I feel are the key factors currently holding back the stock:

  • iPhone Unit Growth: The iPhone 6 & 6 plus’s increase in size caused a massive upgrade cycle over the past year.  Size was the thing iPhone was lacking in most markets outside the U.S. Comparisons to last year’s unit growth of 25% will be tough off of such a large base with what appears to be a very incremental upgrade. So the big fear is that iPhone unit growth will slow at a time where new iPad, wearables and services have shown little signs to pick up the slack.
  • Buybacks and dividends: 80 some percent of the company’s $203 billion in cash is overseas, to increase and continue to fund capital return to the tune of their existing $200 billion commitment, they will need to add to their $55 billion debt load, and are in dire need of an offshore tax amnesty (which Carl Icahn discussed last night in his video Danger Ahead).  Tim Cook may need to get behind a Trump candidacy to grow their capital return beyond 2016.
  • Earnings and Sales Growth: Law of Large Numbers – Even with these buybacks, AAPL is only expected to grow earnings 7% year over year next year in fiscal 2016 (with expected sales growth of 6%).
  • U.S. Dollar will remain a headwind as much of AAPL’s growth is to come from overseas: 60% of AAPL’s sales last year came from outside the U.S., this is only increasing, while China represents about 25% of total iPhone sales. Its our view that dollar strength is here to stay in the global economic environment we are in.

Lastly China.  This has been probably the single most controversial issue relating to the stock since the highs in the Spring, and as Jay Yarrow of Business Insider highlighted in his earnings preview:

Apple’s growth over the past year has been driven by sales in China:

In fiscal Q1, sales in Greater China were up 70% year/year, compared to 30% for the company as a whole.
In fiscal Q2, sales in Greater China were up 71% year/year, compared to 27% for the company as a whole.
In fiscal Q3, sales in Greater China were up 112% year/year, compared to 33% for the company as a whole.

And as I suggested in late September:

It feels like Tim Cook has placed AAPL’s future on the growing middle class in China.  But while China remains a long term growth opportunity, in the near term, it could be a stumbling block if Chinese consumption takes a hit. The fact that an iPhone costs nearly 14% of the annual household income in China means iPhones can go from the aspirational product they’ve become, back into a luxury product they were a few years ago.

That little business of CEO Tim Cook putting himself out there on China growth in his August email to CNBC’s Jim Cramer? Well, that’s the sort of thing that could dog him for quarters, if not years.

Expectations:  Jay Yarrow also had a tidy little comparison of buy-side vs sell side consensus for fiscal Q3 (Sept qtr and for Q4):

-September revenue: $51 billion to $51.5 billion vs. the Street’s $51 billion, which would be up 21%.
-September gross margins: 39.5% vs. the Street’s 39.3%.
-September iPhone units: 48 million to 49 million vs. the Street’s 47.8 million.
-September Mac units: 5.5 million vs. the Street’s 5.7 million.
-September iPad units: 10.5 million vs. the Street’s 10.5 million.

-December quarter revenue guide: $74 billion to $77 billion vs. the Street’s $77  billion, which would be 3.2% growth.
-December gross margin guide: 39% to 40% vs. the Street’s 39.7%.

Estimates & Forecasts from Bloomberg:

-4Q EPS est. $1.88 (range $1.75-$2.02)
-4Q rev. est. $51.04b (range $49.35b-$52.88b); AAPL forecast $49b-$51b
-4Q gross margin est. 39.3% (range 38.8%-40%); AAPL forecast 38.5%-39.5%

-1Q EPS est. $3.22 (range $2.82-$3.59)
-1Q rev. est. $77.15b (range $70.08b-$81.51b)
-1Q gross margin est. 39.7% (range 37.6%-41.5%)

Unit Breakdown:

-4Q iPhone unit est. 48.4m (8 ests.) iPhone ASP est. ~$649 (5 ests.)
-4Q iPad unit est. 10.1m (7 ests.) iPad ASP est. ~$421 (4 ests.)
-4Q Mac unit est. 5.7m (7 ests.)
-4Q Watch est. 4m (3 ests.)

MY TAKE:  It’s been our view since the start of the Summer that not only was AAPL not a No Brainer of an investment anymore as one of its largest shareholders Carl Icahn has repeatedly said, but that the stock, despite its fortress balance sheet and massive commitment to capital return is likely dead money for the time being (read here from June 23rd).

I just don’t see Watch, iPad Pro, Music, Pay, TV accelerating sales growth in the coming year that will see massive deceleration in earnings and sales growth.

from Bloomberg

from Bloomberg

For those who want to own AAPL because it’s cheap, at 12.5x fiscal 2015, and 11.75x expected fiscal 2016 (a lot cheaper ex-cash), I am not sure how they can expect to see multiple expansion next year with much slower growth.

So as I said in late September, I think there are far worse places to park some cash than in AAPL, but I am far less optimistic about the company’s ability to grow eps and sales in double digits anytime soon.  Oh and one more thing, while AAPL does not dominate smartphone market-share, they are leaps and bounds from all of their competitors in profitability.  The company is expected to report gross margins at about 39.3% in the Sept quarter. But it’s important to remember that this is well below their peak from 2012 the year that the company saw gm’s go from an all time high in Q1 at 44.68% to 40% in Q4, the quarter the stock topped out in.  Consensus is calling for fiscal 2015 to be the highest annual gm since 2012, with an expectation for them to be flat in the current fiscal year. This could be a tall task as the high-end smart-phone market continues to mature at a time when emerging market growth may be challenged.

From Bloomberg

Results with a weak iPhone unit number, conservative iPhone units for the Dec quarter and a slightly weaker than expected gross margin guidance and the stock is easily back below $110, possibly re-testing $100 into year end.  This will not be because the AAPL story is over, or that the iPhone sucks, it will because portfolio managers will continue to pile into stocks like AMZN, FB and GOOGL who have the ability to grow sales and earnings at double digit rates.  AAPL looks more like a bond in a low return environment.

If the company were to have pulled in some of the missed iPhone sales from the June quarter, and China was not the problem the market thinks it was (think NIKE’s future’s orders reported in Sept), and the guidance is not as conservative as expected, then the stock is up easily in line to higher than the implied move, but I would be shocked to see an opening gap of 10% like we saw Friday in AMZN, GOOGL & MSFT. This is mostly having to do with the stock’s $657 billion market cap.

We will be sure to follow up with some options trade ideas for those with a directional inclination or happen to be long the stock.  Stay tuned.

 

DISCLOSURE:  I have no position in AAPL stock or options. I am long 2 dozen Apple products accumulated over the last 5 years (business and personal), and a very happy customer.