Overview and Fundamental Analysis
In this article, we will take a look at several ways an Apple (AAPL) bull can take advantage of an upward move in the shares and two ways in which one can profit from consolidation between now and January 2013 options expiration.
As of this writing, Apple is trading at about $585 a share, down from its recent high in September of $705 but up from its recent November low of $505. At this price, Apple is trading for about 10.8 times next year's earnings estimate of about $54/share. For a company growing revenues and earnings at double digit rates and with one of the best balance sheets I've ever seen, this is quite cheap. Apple's PEG ratio is 0.61, once again reflecting the fact that I think Mr. Market is a little too pessimistic on Apple's prospects. This, of course, does not mean Apple can't stay cheap (or get cheaper) but this would certainly suggest at least some margin of safety around current prices. Apple is now going to start selling iPhones in China on December 15th and begin to sell the iPad Mini on December 7th. These are both catalysts for sending the stock higher once sales numbers are recognized for the iPad Mini and iPhones in China.
On the bearish side, Apple's last earnings guidance for FQ1 was very weak, leading some to believe Apple has bigger issues with their most recent product refresh cycle than first thought. While I believe this weak guidance was more of the same under-promise, over-deliver we are used to from Apple, it is worth considering given the large downward revision in estimates. They do have some supply issues for their newer products and margins are under pressure a bit, to mention a couple. However, I think these issues are largely transitory as Apple's ability to feed demand by improving their supply chain will result in greater demand fulfillment and higher margins in 2013 when they become more experienced with making the newest versions of their products.
It is well documented that Apple has the largest hoard of cash in the history of the world, something like $120 per share at the end of FQ4. This is another reason why I believe Apple will have at least some cushion to the downside. This cash pile is a nice cushion to have but with the Fiscal Cliff tax increases on the horizon, some have called for Apple to distribute a one-time dividend (perhaps as large as $30/share) in FQ1 to get some of that cash to shareholders at the current dividend tax rate. This must be taken into consideration when looking at the trades presented below because a special dividend that large can potentially lead to significantly distorted options prices. I am by no means suggesting it will happen, because I don't think it will, but it is something to keep in mind nonetheless.
The daily chart for the past 7 months is below for reference on recent price action in AAPL.
(click to enlarge)
Some Ways to Take Advantage of Apple's Recent Decline
Please note, all option prices shown were the midpoint between the Bid/Ask spread at the time of writing and all Profit/Loss/Break Even calculations exclude commissions. As always, you must perform your own due diligence before making any trades; these are simply recommendations.
Also note the profit and loss graphs include the range of prices in AAPL of $500-$700, which encompasses the recent low at $505 and close to the recent high just above $700.
Each one of these trades is for January 2013 expiration so they are relatively short term in nature.
First, we will look at two ways to profit from sideways action in Apple between now and January expiration.
January 2013 550/650 Short Strangle
This trade involves selling one 550 Put and one 650 Call. The upside for this trade is that it will make money with Apple anywhere between 531 and 669 on January expiration so there is an enormous range of prices where this trade is profitable. The downside is that it requires a lot of margin to put on and opens you up to unlimited losses if Apple moves more than ~10% in either direction. Assuming you don't think that kind of move will happen in the next two months, this is a terrific trade.
The details:
550 Put Price | 11.78 |
650 Call Price | 7.22 |
Maximum Loss | 31.00 |
Maximum Profit | 19.00 between 550 and 650 |
Break Even Point | 531 on the downside, 669 on the upside |
(click to enlarge)
January 2013 590 Short Straddle
This trade involves selling one 590 Put and selling one 590 Call for January expiration. This trade also offers a huge range where it is profitable at the expense of potentially unlimited losses. This trade makes money anywhere between 536.28 and 643.73 on January expiration. Again, this trade is for those of you who think Apple won't move much in the next two months.
The details:
590 Put Price | 27.02 |
590 Call Price | 26.70 |
Maximum Loss | 56.28 |
Maximum Profit | 53.72 @ 590 |
Break Even Point | 536.28 on the downside, 643.72 on the upside |
(click to enlarge)
Now we will look at five ways to profit from an Apple rally into December and January.
January 2013 610/650 Bull Call Spread
This is a very simple way to get some long exposure to Apple without buying the stock while still limiting risk. This trade involves buying one 610 Call and selling one 650 Call against it. This trade is less margin-intensive and also risks a very small amount of the share price, about 2%. The breakeven point is 620.73 so you do need Apple to rally some to start making money, but this is the tradeoff for the small amount of risk being taken.
The details:
610 Call Price | 17.95 |
650 Call Price | 7.23 |
Maximum Loss | 10.73 @ 610 or below |
Maximum Profit | 29.28 @ 650 or above |
Break Even Point | 620.73 |
(click to enlarge)
January 2013 610/650 Bull Call Spread and Short 560 Put
This is essentially the same trade as the one above except with the addition of a short 560 Put. As you can see, this dramatically changes the profit and loss scenarios at the expense of greater downside risks. This trade breaks even all the way down at 548.95 so you have a very large margin of safety on this trade. You will make a small credit from 548.95 to 610 but profits increase very quickly above 610.
The details:
610 Call Price | 17.95 |
650 Call Price | 7.23 |
560 Put Price | 14.70 |
Maximum Loss | 48.95 |
Maximum Profit | 41.05 @ 650 or above |
Break Even Point | 548.95 |
(click to enlarge)
January 2013 545/590 Bear Put Spread and Short 600 Put
This trade involves buying one 545/590 Bear Put Spread and selling one 600 Put. This trade also has a generous margin of safety, with the breakeven point at 539.20. You will receive a decent credit between 539.20 and 590 with profits increasing significantly at 600. This is a great trade for someone that is neutral to bullish. Also, this will require quite a bit of margin.
The details:
545 Put Price | 10.48 |
590 Put Price | 27.03 |
600 Put Price | 32.35 |
Maximum Loss | 39.20 |
Maximum Profit | 15.80 @ 600 or above |
Break Even Point | 539.20 |
(click to enlarge)
January 2013 545/590 Bear Put Spread and 600 Covered Call
This trade is essentially the same as above except the short 600 Put is replaced in this trade by 100 shares of common stock at 585 and a short 600 Call. The effect is nearly identical but this one requires the cash outlay for the shares in case the margin required in the previous trade is too great. In additon, potential profit is greater and losses less severe with a lower breakeven point.
The details:
545 Put Price | 10.48 |
590 Put Price | 27.03 |
600 Short Call | 22.00 |
Maximum Loss | 34.55 |
Maximum Profit | 20.45 @ 600 or above |
Break Even Point | 534.55 |
(click to enlarge)
January 2013 Short (2) 570 Puts and Long (1) 600 Put
Our last bullish trade involves selling two 570 Puts and buying one 600 Put for January expiration. This strategy provides a huge range of prices where it is profitable and an extremely low breakeven point of 535.95. Again, this trade requires quite a bit of margin to put on in exchange for the generous margin of safety.
The details:
570 Put Price (2) | 18.20 each |
600 Put Price | 32.32 |
Maximum Loss | 35.95 |
Maximum Profit | 34.05 @ 570 |
Break Even Point | 535.95 |
(click to enlarge)
Conclusion
I believe Apple will be moving higher once the Fiscal Cliff nonsense is resolved or punted down the road by Congress next year. We have seen two trades to profit from a sideways move in Apple between now and January expiration and five ways to profit if you are bullish, as I am. Given the relatively large price movements Apple has experienced over the past few months, opportunities abound for options traders willing to take some risk. The structures presented are the ones I find most efficient but you can move the strikes or expirations around to better suit your particular viewpoint and risk tolerances. If you have any thoughts or additions to what I have presented, I would love to hear them in the comments section.
Disclosure: I am long AAPL.
