While I have made it a bit of a hobby of trying to poke holes in what was a universal bullish thesis in Apple (AAPL) over the last couple years, I have also of late mentioned on a few occasions (both here and on CNBC) that with the stock now in the low $90s, I’d rather own it, than the S&P 500 (SPX) right now.
Bull Case:
While by no means do I think the stock is done going down, especially if the broad market has lowers lows in the near future, on a relative basis it should outperform the SPX given the fact that it is already down 30% from its all time highs made in April, has 40% of its $521 billion market cap in cash on its balance sheet (30% net of debt), returns capital to shareholders like they have nothing else to do ($153 billion in buybacks & dividends since April 2012 and current div yield of 2.2%), and trades at 10x 2016 expected earnings.
Bear Case:
The big problem with the stock is that all of the above is well known, investors are finally getting their arms around a company that will find it very hard to grow sales off of a $230 billion base, get two thirds of their sales from overseas, where the strength of the dollar is affecting profitability and causing them to defend their margins in regions where their devices can amount to 15% of an annual household income, regions where much of their future growth is expected to come from. Oh and that cash, well almost $200 billion of their $215 billion in cash is overseas, so to fund their capital return ($9 billion last quarter alone) the company has had to raise debt both here and abroad, equaling $63 billion, or 12% of their market cap). While their quarterly free cash flow and on shore cash has been suitable to cover capital return, if sales were to continue to decline, and the company wanted to get aggressive with accelerated share buy-backs as they did in 2013/14, they would need to raise a lot more debt to cover. Lastly, two thirds of their sales come from iPhone, which has dominated market share for high-end smartphones in the developed world. It’s becoming clear that this market is saturated, and with technology where it is, and differentiation becoming far less obvious, upgrade cycles may start to lengthen. This at a time where their two latest product categories iPad in 2010, has actually seen declining growth and was less than 10% of their total sales in the December quarter, and Watch introduced last year has proven to be nothing more than a hobby. There is no clear identifiable category that could offset slowing iPhone sales. I suspect Apps and services will be a part of the next growth leg higher, but for now it is not moving the needle (I wrote about this here) in November.
Technicals:
From a purely technical standpoint, the stock is at a fairly crucial spot. No matter how you decide to draw the uptrend from its 2009 lows, the stock is either sitting right on the uptrend, or would find support somewhere in the mid to low $80s:
Options Volatility Snapshot: It’s been our view for some time that every time options prices pick up in AAPL, they should be sold by long holders. Their massive commitment to capital return is vol dampening, as is the stock’s very cheap valuation, and fortress balance sheet. Investors got the memo. A look at the one year chart of 30 day at the money implied volatility (in blue below, the price of options) vs 30 day at the money realized volatility (white line below, how much the stock is moving) shows options prices at a discount to movement, finally making options prices look relatively cheap:
There are a a couple ways to interpret cheap options prices. In a stock like AAPL, long holders should probably still sell them vs shares they own to generate yield. But for traders looking to make directional bets, they become attractive to define risk, or replace existing risk into potentially volatile events, like the company’s most recent earnings in which the stock declined 6.5% the next day.
MY VIEW:
With the stock down 30% from its all time highs, and considering that the stock had a 45% peak to trough decline from its September 2012 highs to its April 2013 lows, the stock could be worth legging into if it were to break the uptrend detailed above, and find support in the mid $80s.
For those who are not involved and like me looking for an opportunity to leg into a long position, selling out of the money puts is one way to do this. For instance, if you were of the mindset that the stock should perform much better in the back half of the year after their expected release of the new iPhone 7, then with the stock at $93.50, selling the October 80 strike put at $4.70 is on way to do it. If the stock were $80 or higher on October expiration you would receive the $4.70 in premium, or about 5% of the stock price. If the stock were $80 or lower, or 14.5%, lower placing the stock’s peak to trough decline from its April highs at 40%, equal to that of 2012/13’s decline, then you would be put 100 shares of stock for every option sold, but your effective purchase price would be $75.30 (the put strike less the premium received) down about 19.5% from current levels, or about 45% from its all time highs in April.
If the stock stays solidly above 80 for some time, that put will decay over time.But the most you can receive is 4.75. So for those then looking to use that put to finance the purchase of calls you could use the put sale as the first leg of a risk reversal strategy, and buy an upside call like the Oct 100s. That tarde would be even or even a credit if the broader market took AAPL below $90.
We’re not ready to step in yet on AAPL, but it is on our shopping list if it gets back below $90. In that scenario we’d possible do a risk reversal strategy, or if vol is extremely high look at buy-writes or at the money put sale trades or even in the money butterflies targeting a slow move back towards 100. Stay tuned.