I have just made a simple bet that come Jan. 18, 2013, Apple (NASDAQ:AAPL) will be trading at some price above $500. As I write this, AAPL is at $513. This little bet will make 62% after commissions at any ending price above $500. It doesn't have to go up a penny to make this much in a single month. In fact, it can fall $13 and the same gain will come my way.
One of the biggest stock market mysteries I have experienced in 30 years of trading almost every day has been the recent implosion of Apple stock. For years, I was on the lookout for companies whose P/E ratio was less than its growth rate.
Two months ago, when AAPL was trading north of $700, its growth rate was more than double the P/E ratio (not adjusting for cash), even taking the traditionally conservative company projections for next quarter. Opportunities like this are quite rare in the investment world -- at least they have been in the past.
Since that time the stock has fallen nearly $200. I was not alone in my surprise at such a drop. According to Yahoo Finance, the median average price target for 48 analysts is $750 (the mean average is $754). How can so many presumably smart (and well-informed) people be so horribly wrong? Maybe in the longer run they won't seem so stupid.
Trying to catch the bottom of a falling stock has been compared to catching a knife dropped from a great height (with your bare hands, of course). I must admit that I have made several attempts to catch a bottom over the past two months, and my portfolio value has dropped right along with the stock. It has been a painful time for us Apple bulls.
But now I think the bottom is finally here. From a technical standpoint, there seems to be a strong resistance point at $505. I'm not much of a technical indicator guy, but so many people follow those numbers that sometimes you just have to follow their lead. The stock fell to $505 a couple of weeks ago, rose sharply, and then retreated to test that level once again last week, and has since recovered a bit.
There have been dozens of Seeking Alpha articles that have tried to explain (or justify) the reasons that Apple has tanked like it has. Many attribute the recent sell-off to tax-related selling. If a person had a huge gain in the stock (and anyone who has bought it in earlier years surely has), it might be better to sell your shares in 2012 to avoid what looks like a higher long-term capital gains rate that may be instituted in 2013. Many people are expected the rate to increase from 15% to at least 25% next year. That would make it a good time to take some profits.
Anyone who sold AAPL for tax reasons probably still likes the stock (after all, it did give them a big win) and may buy it back once they read about millions of new iPhone 5 sales at Christmas and in China (and now, even at Wal-Mart) and anticipate what those sales might mean to earnings.
There are many other reasons that the stock should be trading higher in 2013, and someone will surely write an article that itemizes a dozen of them soon. Regardless of the actual reasons, the bottom line is that the stock usually spikes higher in advance of the January earnings announcement, which should come just after the January options expire. When the announcement is made, the P/E ratio will surely be even lower than it is today since this will be the first quarter when the iPhone 5 results are in (the most profitable Apple product, and the biggest problem has been making it fast enough to keep up with the demand).
So here's the little bet I made that Apple will be trading at some point higher than $500 on Jan. 18, 2013:
I bought AAPL January 2013 495 puts and sold January 2013 500 puts, collecting $195 per spread, or $192 after commissions (in options lingo, I sold a vertical put spread). At any price above $500, both options will expire worthless, no commissions will be due, and I will make a gain of $192 on my maximum risk of $308. That works out to about 62% on my money at risk. Not bad for one month.
If the stock closes at any price below $495, I will have to buy the spread back for $500 and I will lose $308 (the maximum risk I am taking). My broker will issue a maintenance requirement for $500 per spread (this is not a loan like a margin requirement, but $500 per spread will have to be set aside in the account). Since I collected $192, my actual net charge will be $308. By the way, this kind of a spread is allowed in IRA accounts at most brokerages, including thinkorswim brokerage.
I get a kick out of Seeking Alpha authors who advocate selling naked puts on Apple (see "A Safer Way to Play Apple") who calculate the return (about 3.2% on the trade, based on the near-$50,000 margin requirement) and report that your return is 70% (which is the annualized return if you sold the naked put every 17 days for an entire year). Using that reasoning, the little bet that I just made works out to 744% if I am right.
I am far more comfortable with risking $308 to make $192 than I am to risking $50,000 to make the $1,600 that the "Safer Way" article advocates. Even if you are risking only $308, of course, you should only take this risk with money you can afford to lose.
Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.