Apple (AAPL) Core

by riskreversal January 4, 2017 3:59 pm • Trade Ideas

Shares of Apple (AAPL) closed up 10% in 2016, gaining a little more than $60 billion in market capitalization in a year that saw their first year over year decline in earnings and sales since the early 2000s. Some would say last year’s price action is discounting good news to come in 2017, but with all of the gains coming since the election it might have more to do with this schedule of AAPL’s cash return since 2012, and their exploding cash balance (most overseas), and the likelihood of tax repatriation this year to boost the former, truly astounding to say the least:

As for AAPL’s fundamentals, it’s always been about their product cycles, which for the better part of the last decade has primarily been driven by mobile devices, while the level of innovation and global expansion opportunities have been the intermediate term driver for the stock’s performance. But 2016 saw the third iteration of the iPhone 6, a MacBook Pro that was not recommended by Consumer Reports, a less than exciting update of the Watch and no new iMacs and meh refreshes of iPad and AppleTV.  Union Square Venture’s Fred Wilson, summed up the lame state of AAPL’s products in a blog post; What Did And Did Not Happen In 2016:

Apple certainly seems wobbly. They can’t make laptops that anyone wants to use anymore. It’s no longer a certainty that everyone is going to get a new iPhone when the new one ships. The iPad is a declining product. The watch is a mainstream flop. And Microsoft is making better computers than Apple (and maybe operating systems too) these days. You can’t make that kind of critique of Google, Amazon, or Facebook, who all had great years in my book.

While I agree with all of that, I would add that the company’s late introduction of the Airpods, the company’s second shot of a wearable device is a slam dunk of a product, even at its $160 price point. The product has received mixed reviews, but as someone who owns two pairs (my wife and I have each been using for a week with our iPhone 7s), I can tell you that it is the most innovative product I have bought from AAPL in years, and very well may signal a more enthusiastic path to success in wearables than the two iterations of the Watch.

On that note, in Wilson’s blog post he stated the following, which I believe was a massive miss on AAPL’s part in their effort to take smartwatches mainstream:

Fitbit proved that the main thing people want to do with a computer on their wrist is help them stay fit. And yet Fitbit ended the year with its stock near its all time low. Pebble sold itself in a distressed transaction to Fitbit. And Apple’s Watch has not gone mainstream two versions into its roadmap.

The next identifiable catalyst for AAPL will be their Fiscal Q1 results due the week of Jan 23rd. The options market is implying only about a 4% move between now and the close of business on Jan27th which will include the earnings event. With the stock at $116 the Jan 27th 116 straddle (the call premium + the put premium) is offered at about $4.70, if you bought that, and thus the implied move you would need a rally a move $120.70, or a decline below $111.30 to make money. For reference, the implied move into the company’s fQ4 results in Oct was also about 4% in either direction and the stock declined only 2.2% the following day, well below the 10 year average one day post earnings move of about 5%. AAPL missed consensus for fQ4 but guided a better for fQ1.

Per usual this time of year there have been rumors of AAPL scaling back iPhone production of the current quarter,. which makes sense 3 and half months after the iPhone 7’s release, and shortly after their bulked up holiday selling season. But before anyone gets too geeked up about the innovation demonstrated in the Airpods and the prospects for a new Watch in April, it’s important to note that those two products fall in the Other Products category in AAPL’s product revenues, and in fQ4, that group accounted for 5% of the company’s total sales (highlighted, does not move the needle):

I suspect the company meets fQ4 when they report, but likely guides down for fQ2. Partially a result of a holiday hangover, but also the strength of the U.S. dollar since they guided. The DXY is up nearly 5% since Oct 25th, the company gets about 55% of its sales from outside the U.S. and the dollar could be a headwind to guidance. Oh, and the bump the company might have gotten from Samsung’s Galaxy Note 7 disaster might abate and iPhone users might start to push-out upgrades as rumors of the impending 10 year anniversary iPhone start dominate the tech news flow. Lastly, those expecting a dramatic increase in the company’s capital return will not get any meaningful news until there is some clarity on overseas cash repatriation, which will likely take months, and the company historically does not update their cash return until March/April following their annual shareholder meeting.

Holders of the stock with a short term time horizon might consider long stock replacements into the company’s fQ1 with an eye towards protection/defined risk in case of weak guidance.

The stock was recently rejected just below technical resistance at $120, but if the stock were to have a reason to get above on a beat and raise it could be a straight show to the prior all time highs from mid 2015 at $133.50, thus justifying continued long exposure:

AAPL 2yr chart from Bloomberg

Earlier today we highlighted a couple trades (here and here) where we saw traders better define their risk by selling out of the money puts to buy out of the money call spreads, a strategy that may make sense in AAPL for those looking to play for further upside, yet are willing to be put the stock at much lower levels if the company were to disappoint.

Stock Alternative in lieu of 100 Shares of AAPL ($116) 

Buy the March 105 put – 120/130 call spread risk reversal for 75 cents
  • Sell to open 1 March 105 put at 1.05
  • Buy to open 1 March 120 call for 2.25
  • Sell to open 1 March 130 call at .45

Rationale – This stock alternative provides 10+ dollars of room to the downside before being put the stock, and allows participation from 120/130 like stock (less the .75 debit). This is only for those that are either long the stock, or considering buying the stock as you must be willing to be put the stock at 105 on a decline.

We’ll follow up on this idea and others as we get closer to earnings.