On January 22nd we warned time-sensitive Apple Inc. (NASDAQ:AAPL) investors that while the stock's future prospects were being appraised by market-makers as approaching long-term investment value, they saw continuing near-term weakness.
As it often does, that weakness presented itself earlier than might have been expected two days later, by a one-day, 12 ½% price drop of 64 points, from 514 to 450. Trading volume nearly doubled from 30 million shares to 52 million.
Now a recovery appears to be under way. But is it real, maybe a turning point, or is it only another head-fake on the way further down? Investors, both of a long-term persuasion and those of the time-sensitive camp, need to review their strategies.
All manner of fundamental developments in Apple's competitive scene have been examined by SA contributors over the past few months. As usual in a well-functioning market, arguments can be made, and supported, for both directions of price change.
Our regular readers are aware that our resources are usually of greatest value to investors who utilize their time well by careful selection and focus of capital on investment candidates where prospects provide opportunities nearer at hand in time. Also served are those investors who recognize that the long term is but a sequential series of shorter terms which often provide openings for rebalancing of commitments.
For those willing to keep alert, the establishment-scorned "market noise" regularly provides cumulative rates of return that are super-competitive with the single-digit annual rates academically accepted as "norms." To get insight into the "noise" we look to the everyday professionals most immersed in it, the market-makers, as indicated in the article referenced at the start of this message.
Their self-protective actions in helping big-money fund clients navigate into and out of AAPL provide a continuing and detailed array of potential price prospects. Here is a view of the aggregates of what their actions have implied over the past six months.
(Used with permission)
The vertical lines show the extent of prices against which the market-makers are willing to pay, out of their potential trade spreads, for option price insurance to protect their firm's capital that must be put at temporary risk in completing volume trades. The heavy dot is the end-of-day stock price.
Their risk exposures are usually limited in time to hours or days, so hedgers normally seek the shortest coverage available. Often the protection markets are not sufficiently robust to accommodate the volumes being sought in short-term protection without driving costs up, so longer-term contracts are used to fill the shortfall. Arbitrage activity within the listed options markets keeps all the various alternatives economically related, so that a price tug on any part of the spiderweb has an impact on many others.
In the case of AAPL there are typically ten to a dozen different contract expiration dates, reaching out in time to almost a year. Within one expiration there may be up to 150 strike prices ranging from $250 to over $1000. Each contract represents 100 shares, so a 100-lot position has a notional value of $5 million with the stock at $500.
Most AAPL expirations have an open interest of thousands of contracts. Individual investor influence in this marketplace is imaginary at best, and at worst, delusional.
In our earlier-referenced article we revealed the detailed by-expiration make-up of the AAPL forecast for January 18th. Here is how it looked on that date at each successive contract expiration.:
Now compare that with the 9/18/12 AAPL top,
and a month later, when downtrend fears set in,
and where we are now:
At the top in September, few signs of the impending decline were apparent. Longer-term expectations saw prices well up into the $800s. But the ones that mattered were in the immediate expirations, where a full month remained on the October contract, yet market-makers saw no need to hedge short positions less than 1% above at-the-money.
Meaning: "This rally is out of gas."
On the downside, exposures beyond -1% in October, and -2% in November were not worth covering. Meaning: "Nobody's scared at this point, just stand by and watch for direction."
As evidenced above in the blue-background picture of daily forecasts, that direction soon developed. It was recognized as a trend by the October expirations when nearly 100 points had disappeared and the scare component reduced upside potentials in contract negotiations for the remainder of the year.
Our review in January, the first table above, showed heightened professional downside concerns by the time the stock dropped its second hundred points. Lots of protection was being bought down to the $470 area, even a bit beyond. Hence our caution, as expressed.
But even that wasn't enough.
Still, it may just clear the air, since the concerted one-day action, while a $3.3 billion withdrawal of incremental capital from the AAPL sandbox, did not bring on a cascade of further professional liquidations - less than another half billion the next day, including some scared individual investors, no doubt. Since then, nothing.
Our read on Friday's close provides some interesting insights. While near-term downside protection is being bought in ordinary proportions, beyond the next couple of months the downside is being swept aside. May expirations offer a price range low above the current $475 market quote.
All through this decline the upside forecasts have remained in the range of +20% to +25% above the current price. That margin was smallest at the $702 top and held firm in 6-month forecasts even when the downside concerns were greatest. There appears to continue to be a strong cadre of long-term believers, both individual and professional investors.
Time-sensitive investors may want to have a little more evidence of further recovery strength, but this looks like a pretty good re-entry or allocation reinforcement time and price point, based on the market-makers reading now of probable big-money fund behavior as we go on.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.