Trade Idea – $AAPL Harvest

by Dan November 10, 2015 2:19 pm • Commentary

Regular readers know that we think Apple (AAPL) stock is likely to be range-bound (dead money) for the time being. Here were my comments from Oct 28th following their fiscal Q4 earnings:

Things are good at AAPL. But they may be as good as it gets until we see a ramp into the iPhone 7 (expected in September 2016.)  While bulls will point to a continuation in growth in China as the engine to fuel the stock, I still think China poses more risk in the near term than it does reward. A material deceleration in sales would cause a meaningful selloff in the stock as China is the company’s big hope.  They can talk about switchers and upgraders all they want, but it does appear that in mature smartphone markets the upgrade cycles are stretching out a bit. Let’s see if the company’s leasing program can accelerate this process. My guess is it’s only a marginal improvement at best given the lack of differentiation in the most recent iPhone 6s upgrade.

As I have suggested for months now (here in June), I think the stock will remain devoid of new catalysts, and is likely dead money for the time being.  For those of you in the own Apple, don’t trade it camp, (which I think is a questionable approach to risk management, read here and here) you may want to consider an actively managed call overwriting campaign against your long stock in an effort to add yield to a stock that is likely to be range-bound until the company can demonstrate a new product category that can move the needle on their $234 billion revenue base.  (We’ll try to regularly detail yield enhancement overlays on the site for AAPL shareholders.)

In sum, I see far worse places to park some cash, but I think it is important to remember that much of the stock’s massive 800% plus run from its financial crisis lows were driven by new innovative products in a fairly under-penetrated mobile computing market.  Market share gains in developed markets could become a story, a reemergence of left for dead categories like iPad, and unexpected success in services or wearables could all be catalysts, but they remain elusive at best in the coming months. For the stock to get back on its horse, the company will need to maintain the growth in China and make progress in other emerging markets at a time when global growth appears to be under a strain.

Nothing has changed my opinion in the last couple weeks, and as promised in the prior post, I want to offer a yield enhancement opportunity for existing longs.  Today AAPL is down 3.25% on a research note from Credit Suisse suggesting that orders to component suppliers to the iPhone have slowed of late, which could speak to a deceleration in iPhone unit sales at a time the company faces difficult comparisons from its 6 cycle upgrade from a year earlier.  This is all noise, until it’s not, but I suspect that the stock down 13% from its all time highs in the spring and its below market and peer multiple reflects a lot of this pessimism.  The company’s massive commitment to capital return will likely keep the wheels on the bus, one of the main things the stock did not have going for it during its 45% peak to trough decline from Sept 2012 to June 2013.

So What’s The Trade?

vs 100 shares of AAPL ($116.20) sell the Dec24th (weekly) 105/125 strangle at 2.15

-Sell to open 1 Dec 24th weekly 125 call at 1.10

-Sell to open 1 Dec 24th weekly 105 put at 1.05

Break-Even On Dec 24th weekly expiration:

Profits: of stock between current levels and 125.  Gains of the strangle sale if the stock is between 105 and 125

Losses: if the stock below current levels. But the strangle sale adds a $2.15 buffer to the downside.  Additional losses to existing position, if stock below short put strike of 105, as if long another 100 shares.

Rationale – This adds just under 2% in potential yield on underlying shares over the next 6 weeks, a period that could see lower levels of volatility given the upcoming holidays. The risk on the overlay is being put 100 shares of stock at 105 or lower, and having 100 shares of long stock called away at 125 or higher. So a long holder is giving up potential upside, and having risk to adding long exposure on the downside for the potential to add 1.85% yield if the stock remains range-bound between 105 and 125.  If the stock were approaching or through either strike heading into Dec 24th weekly expiration, you could simply take off the short strike to keep the long stock position intact.

The ideal situation for long holders would be for the stock to grind higher have the gains of the stock, and cover the short strangle for a gain close to expiration.