Hedge and Stock Alt review: $AAPL

by CC April 29, 2016 12:11 pm • Commentary• Trade Ideas

With earnings season comes idiosyncratic single stock risk. We all know that and in many ways its one of the very things that attracts us to trading individual stocks vs etfs. But what can be done to protect existing positions against large moves following earnings reports? This week we attempted to preview some of the largest and widely held tech stocks (AAPL, FB, AMZN) and offer ways to better define risk into potentially volatile earnings events.  With the week winding down, and some massive moves moves behind us, I wanted to take the time to review those strategies and see what worked and what could have been better.

First to report this week was Apple (AAPL). We were worried about a move below 100 in the stock and wanted to define risk as less than the implied move to the downside as a stock alternative, as well as a simple hedge for those that were long the stock and worried about it breaking $100 to the downside. Here were the trades, first a simple hedge for those long the stock:

against 100 shares of AAPL (104.50) Buy the April29th 100 puts for .80

Rationale – This simple put purchase is for those that just can’t stomach a move below 100 on earnings (inline with the implied move to the downside). It basically protects against any large moves outside the implied move to the downside with unlimited protection below 99.20, for less than 1% of the underlying. Buying puts to protect shares into an event every quarter is a good way to leak gains over time, but in the case like this where 100 may be a breaking point for longer term share holders it may be money well spent to keep your long stock position in tact with defined risk.

AAPL did indeed break 100 and it’s been ugly ever since with the announcement that Carl Icahn had exited his entire holding. With the stock now 92.70, those puts that cost just .80 are now worth 7.30. That means that .80 paid saved 6.50 of this decline. That’s money well spent and allows for some flexibility. As far as trade management, if you’re sickened by this move and just want to throw in the towel, you let the puts expire and that will be the equivalent of selling your shares at 99.20, hopefully at a profit from an initial purchase much lower. for those that will only have AAPL stock pried from their cold dead hands (in other words, long term investors) you can either start to buy back the stock here or just sell the puts (which is the same thing) locking in the 6.50 profits in the puts.

The next trade we looked at in AAPL was a stock alternative that defined risk in case of a sharp move lower. This is a good strategy into an uncertain event for those already long or those looking to get long as you know exactly what you can lose:

The other way to define risk is for those that want to be long AAPL is an in the money butterfly where you know what you can lose on a sharp move lower, and nothing more:

In lieu of 100 shares of AAPL (104.50) Buy the May 103/113/123 call butterfly for 2.80
  • Buy 1 May 103 call for 3.70
  • Sell 2 May 113 calls at .49 (.98 total)
  • Buy 1 May 123 call for .08

Rationale – This limits risk in the stock to about 2.6% of the underlying while providing the potential to gain 7.20 on a move higher to 113 on May expiration. The 113 target is just above the intraday highs in 2016. The trade breaks even at 115.80 so not much is being paid in premium vs the current stock.

With the stock 92.70 this trade is worthless. But compared to the stock being down nearly $12, losing only 2.80 is exactly why you do this trade as opposed to owning or buying stock. Those that want to be long AAPL from here on out or used this strategy as a stock replacement can simply let it expire worthless and start buying stock back at the time of their choosing, at a much lower cost basis that into the earnings event.

And lastly, Dan has had some fairly pointed comments about AAPL’s fundamentals over the last year, but most recently he has been highlighting the 5 year and 10 year charts of AAPL that may be instructive to where the stock could find some support on the downside.

First the 5 year, its right back at the August and Jan/Feb lows:

From Bloomberg
From Bloomberg

A break here and we could very easily see a re-test of the long term uptrend in the mid to low $80s:

from Bloomberg
from Bloomberg

In the low $80s AAPL will have a market cap which will be about double their $230 billion in cash on their balance sheet, with a dividend yield of close to 3%, and at that point for those patient investors, the stock very well be very near a no-brainer.