How To Play Apple's Earnings This Tuesday

Apr.22.13 | About: Apple Inc. (AAPL)

Apple will report their earnings Tuesday after hours and investors are anxiously awaiting the corresponding action in the share price. Options trading (based on straddle prices) has suggested that investors are expecting at least a 7.5% change on Apple's (NASDAQ:AAPL) share price after earnings.

Here's what the street is expecting, from CNBC.com:

Analysts are projecting revenue to grow 8 percent to $42.49 billion, while earnings per share are expected to drop 18 percent, according to Thomson Reuters.

The public is now betting on the bearish side of Apple almost certainly, and as I've often contended, "fading the public" isn't always a bad idea. As I wrote in "My Definitive 17 Cardinal Rules of Investing Success."

"We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful."

- Warren Buffett

In sports betting, when one side of a game is overwhelmingly being bet on by the public, the line on the game moves. Similar is the way the price of a stock moves in accordance with the demand. More sells than buys, price moves down. More buys than sells, price moves up.

"Fading the public" simply means doing the opposite of what the public is doing. It's important to not blindly just do the opposite of what the public is doing; the public creates important trends that need to be respected and noticed. In the world of sports betting, the benefit is usually a couple of extra points on a line; in finance, the benefit is usually a cheaper share price to buy at or a higher share price to sell at. Keeping your emotions in check is vital, as I'll discuss later. These strategies play off the emotional instability of the common investor.

Keeping yourself in this mindset of doing the opposite of the public is how big money makes money, and how you can, too. The sooner you start to think like one of the sharks, the less chance you have of becoming eaten alive.

What I'll be looking to do here is take the volatility that is definitely going to be coming in the trading that occurs post earnings, and use that to make money.

Apple has lost almost $300 billion in market cap over the past few months, so the attitude going into this call has to be one of some urgency to create value for shareholders. Confidence in the company is waning, against the fact that the company is the most fundamentally sound one in the world. CEO Tim Cook and CFO Peter Oppenheimer need to pull a rabbit out of a hat, amuse and amaze, and put on a serious show with this earnings call if they don't want to lose another $100 billion in market cap.

Also, let's not forget what Apple CFO Peter Oppenheimer announced after the last earnings miss. I wrote about this in a past article:

In their last earnings report, Apple announced $54 billion in revenue and a cash position of $137 billion that makes Donald Trump's net worth look equal to the net worth of a guy that changes the urinal cakes at the airport; they're not exactly worried about the power to the building being cut anytime soon. It's beginning to dawn on investors that analysts were a big catalyst in the downfall of the share price.

Apple's CFO Peter Oppenheimer obviously realized this was going to be an issue and, while accepting that it was going to lead to short-term recalibration, thought it would be better for the long term to offer guidance a bit more responsibly. As, this article notes:

In the past, Apple has provided a single point, (one revenue figure, for example), the company expects to hit over the course of the upcoming quarter. Apple is notorious for releasing conservative numbers then blowing them away when it reports earnings a few months later.

Now, things will change. Instead of offering a single point, Apple will begin offering a range.

Peter Oppenheimer explained the change on the Apple's Q1 2013 earnings call, which is going on right now:

"In the past we provided a single point estimate that was conservative. This quarter and going forward, we are going to provide a range of guidance that we're likely to report within."

What does this mean? It means that the last guidance offered was a big recalibration for not only analysts, but the market and retail shareholders. Everybody is so used to Apple annihilating guidance as they'd done in the past, analyst expectations have gone astray and needed to be roped in by Apple executives. 18% year over year revenue growth and substantial recurring growth with impressive margins for years now -- and this kind of panic sets in on a small share of a miss on earnings? Simply baffling.

This was a savvy move for Oppenheimer. He's taking the analysts from a push to a pull, essentially saying: this is our company, we're selling our product, we have the best interest of the shareholders in mind; we're going to be the authority on guidance.

Oppenheimer is going to be praised in the future for this recalibration. There's no doubt he knew this last earnings call was going to be ugly, but from this point forward his new strategy will be kept in mind, allowing analysts and retail's expectations for earnings run commensurate with the company's.

The street, along with me, still contends that Apple is a good buy here.

In a recent Yahoo! article:

Apple is currently trading at nine times trailing earnings and 45 of 58 analysts polled by Reuters give the stock a "strong buy" or "buy" rating. According to Thomson Reuters Starmine, Apple's intrinsic value - a price target based on expected growth rates over the next decade - was about $565 a share.

I'm extremely long-term bullish on Apple, so if I had the means I would be going long the equity and writing calls -- maybe $450's or above, to insure my long position that I'd be taking around $400. I recently bought Apple calls at $396, as I stated last week:

I've been calling Apple a buy since its fall from $530 and I'm going to continue to do so until it blows back through six and seven hundred. At $396, this was a great place for me to open a new position, and a nice opportunity for people already in Apple to average down. This stock continues to try and find a bottom amidst sensationalist headlines that are front page stories on blogs and financial websites every day.

Surely, you're going to need a good reason to go long a stock like Apple in the midst of its extremely unceremonious decline over the last few months. Here's some of the reasons it was easy for me to hit "execute" on the Apple trade:

  • The price is right. There's nothing I love doing more than buying after a strong sell off and selling right after a strong buying panic. I took this week's 6% sell off first thing as a cue to buy.
  • It's the most fundamentally sound company in the world. It's raking in cash hand over fist, earnings "misses" are laughable as their revenues and margins are beyond world class still, and the company is sitting on enough cash to make Donald Trump look like your high school janitor.
  • Treats are coming for loyal shareholders. It's been alluded to time and time again since Einhorn has started pressing shareholders to demand that Apple unlock their cash. CEO Tim Cook had alluded to it dozens of times, and it's only a matter of time before shareholders wind up with an added bonus like increased dividends, preferred stock, or share buybacks.
  • Whether it's the iWatch, the iTV, or god knows what we can expect a new product launch from Apple this year. With new products come free press, consumer excitement, and brand new revenue streams and market shares to tap into.
  • Apple's purchase of WiFiSlam is a sign that they continue to do what they do best; develop.

The plan to sell is during the summer. Everybody needs to take a deep breath here with Apple. We're going to get product releases, dividends will be paid, and Apple will not continue to miss earnings every single quarter from now until the end of time. As Apple finds its bottom point (trading around its 52-week low right now as we speak), it's going to eventually wind up becoming oversold and correcting. The RSI, as we speak, is 28 and change; we're heading well into oversold territory.

$130 billion in cash on hand; that's all the security blanket and comfort pillow this investor needs at the end of the day.

I think positive catalysts in their report could be directly linked to the 5 reasons I stated above. If Apple touches on any or all of the following, there's a chance the stock could be heading back to $500:

  • Numbers that beat the street
  • New products
  • Specifics of WiFiSlam purchase
  • Cash back to shareholders

Conversely, because Wall Street already has bearish momentum on Apple, a meet or miss is going to pull us significantly lower. A safe way to play this volatility could be an options spread.

I also like the April 26th $390 straddle. The calls are $14.85 and the puts are $14.20, which is putting you at a breakeven of $29.05 in either direction, plus your commission costs. To make money on the put side, you'd need to see $361, which I'm confident it'll go well below on bad news. This chart shows major support at the $350 region, which is where I contend we'll head on bad news:

(click to enlarge)Click to enlarge

On the call side, we'd need to see $419.05 to make a score. If earnings are a blowout, I contend we could see well above $419.

The inherent risk in this strategy lies in a situation where Apple stock doesn't respond sharply in one direction. This is a risk that yields major profits if you buy long and write out of the money calls, however.

A likely scenario where that could happen would be one in which Apple simply meets, or just barely exceeds earnings. If this risk is of concern, going long options with expiration towards the end of the year or even buying LEAPS (2014, 2015) could help hedge that. The more time value built in, the more expensive the contract will be, but with the advantage of time on your side you may find yourself in a situation of being able to cash both sides of the spread; or at the least, cut losses from 100% on one end.

Going into earnings, I'll be loaded 2:1 calls to puts, as I'm still bullish. I'm going to try and play a spread as insurance and buy calls on top of the ones I already have.

No matter what strategy you decide to use on Tuesday, I wish you the best of luck, and hope you enjoy the entertainment of another Apple earnings release.

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.

Additional disclosure: I have AAPL calls and may buy an options spread before earnings tomorrow, if I can locate my gonads before such time.