Apple (AAPL) – Turnover Protection

by Dan June 2, 2017 1:24 pm • Trade Ideas

Next week Apple (AAPL) will hold its annual software developer event in San Jose, WWDC. In years past, on top of highlight significant changes to its operating systems and software services, which is the main function of the multi-day conference, the company has also used the spotlight to introduce new hardware products, which will all know for the last decade has been the primary driver for the company and the stock. But as Wired’s David Pierce suggested in a preview of the event this morning, “this year’s conference… has Apple at an interesting crossroads”:

The gadget-buying world is hyped beyond reason for the tenth-anniversary iPhone, but that’s likely not coming until this fall. (Or even later.) Meanwhile, most of Apple’s other products face some headwinds. The MacBook Pro with Touch Bar was met with a resounding meh. The iPad, the supposed future of computing, still can’t find a way to grow. The Apple Watch 2 still needs a killer app. The Apple TV, well, the Apple TV hasn’t exactly blown up the industry the way the folks in Cupertino wanted. Apple Music is losing to Spotify; Siri seems to be running a distant third behind Alexa and Google Assistant. Let’s be clear, Apple’s not doomed. Apple is still dominating the tech world. But there’s still that unshakeable feeling that the company’s moxie may be missing.

Despite all of the above, Pierce suggests that next week’s WWDC will be one of their most important in years:

Siri will almost certainly be the star of the show, as Apple tries to keep up in the raging virtual-assistant wars. Siri will surely have new skills and new integrations, and Apple could even announce wider developer support. Right now, only certain apps can only do certain things with Siri, but opening the platform completely could change things quickly. Meanwhile, Apple’s most exciting new product could be the long-rumored Siri Speaker, Apple’s answer to the Amazon Echo and Google Home. We still don’t know much about the device, but it’ll reportedly be a HomeKit controller, a Siri machine, and an always-on speaker with supposedly superior sound. Throw in some Apple TV remote skills, and we’re really talking.

VOICE is one of the most important new platforms to emerge in consumer tech in years, and any consumer electronics or mobile service company needs to not only have an offering but a reliable one. And while SIRI was introduced in 2011, long before Amazon’s Alexa and Echo device, and Google’s Assistant and Home device, and despite AAPL’s 1 billion plus iOS installed base, the company’s voice assistant is severely lacking to that of AMZN’s Alexa, in both quality and use cases, and the company has yet to introduce a hardware device similar to Echo. If the rumors are correct (here), and AAPL will introduce a Siri Speaker next week, I suspect the first shipments won’t come for months, and to be in short supply when they do if the launch of the Airpods and the Watch are any indication of recent hardware launches.

Expectations are not running high into the event, which is also reflected in the options market. The June 9th weekly at the money 155 straddle (stock reference $155) is offered at about $2.70, or about 1.7% of the stock price, so if you bought that and thus the implied movement for the next week you would need a rally above $157.70 or a decline below $152.30 to break-even on next Friday’s close. Given the stock’s 33.5% year to date gains, and 8% gain in the last month alone, the implied movement into the event feels fair to cheap, with one caveat… maybe the market has it right and nothing announced on Monday will likely affect the stock as investors are bracing for the expected iPhone supercyle that should take effect with the release of their 10th anniversary phone in September or October. There is clearly risk to the trade into what is certainly high expectations in the fall, as there have already been rumors that the tricked out iPhone with Oled curved screen will cost as much as $1000 and might not be available till November and the other phones they launch in the fall will have the same formfactor as the 7/6s/6, which might not be the thing to cause an upgrade wave.  The bull case for this though is that there is close to 300 million iPhones in use that are at least two years old and eventually they will all need to rush to upgrade. But this chart from the WSJ yesterday shows the first year over year decline in iPhone shipments, bulls hope that the new phone will re-accelerate growth.

WSJ

This was exacerbated by the dramatic drop off in AAPL’s once great growth market, China, which saw 100% year over year quarterly sales increases in fiscal 2015 give way to a string of 25% declines in fiscal 2016, and despite so leveling off, still remain negative (down 12% and 14% iin the first two quarters if fiscal 2017).

WSJ

With the eye-popping gains in the stock year to date, the stock is far from a lay-up from here. Long holders might consider defensive strategies that allow for potential upside to a point, but define risk on the downside and lock in profits. Versus long stock, a collar, selling an out of the money call to help finance the purchase of an out of the money put makes sense into this product cycle.

For instance, targeting the companies fiscal Q3 earnings that should fall in the last week of July, holders who are worried about a weak quarter and forward guidance, and possibly a broad market sell-off this summer should consider zero cost protection:

(vs 100 shares of AAPL at $155), Buying the September 140 / 170 collar for even $

-Sell to open 1 Sept 170 call at 1.75

-Buy to open 1 Sept 140 put for 1.75

Break-even on Sept expiration:

Profits of stock up to 170, or 10%, gains capped at 170

Losses: of stock down to 155, or 10% but protected below that.

Rationale: the stock has been a one way train in 2017, and if you see no reason to get off that train, but are worried about some sort of unforeseen event, or some sort of execution hiccup causing the stock to retrace a bit of the ytd move then it may make sense to give up some potential to protect profits.

The choice of the call strike might be a bit arbitrary as there is no upside technical resistance but on the downside $140 was recent technical support before the stock broke out to new highs and the risk reward relationship is symmetrical and causes the collar to cost nothing.

From purely a technical level, $140 near term support also intersects with the uptrend that has been in place from the post-election November lows that has seen the stock rally nearly 50% since:

Bloomberg

If the stock continues higher this collar would see mark to market losses, but nothing counts unless the stock is above 170, and if it started approaching that level the collar could be rolled higher with minimal losses on the hedge vs profits in the stock.