Apple Slingshot: Trade of the Year

 |  Includes: AAPL, QQQ
by: Jason Schwarz

For hedge funds, Apple (NASDAQ:AAPL) is the battleground of a broad market war. If they can move Apple up, the rest of the market will follow. If they can move Apple down, the rest of the market will follow. Since October this Apple slingshot action has happened six times; it's time to document a seventh.

On February 25th Apple was at $196 and it jumped $23 in the next six trading days. The slingshots move in approximately $20 increments. At we reinvested in our Apple/QQQQ slingshot trade on the morning of February 25th, and the Apple January 2011 $250 call options have gone from 8.55 to 13.95 (a gain of 63 percent). The QQQQ June 2010 $41 call options have gone from 3.95 to 5.89 (a 49 percent gain). Not bad for six trading days. So what should we do now?

Should we take profits and plan on Apple dropping $20 like it normally does or is this finally the run that takes Apple up to higher levels? We'll wait to see Apple reverse against an up market before selling out of the position. If recent history is an indicator, this is the moment to sell out of the Apple/QQQQ long position and rotate into some hedges for downside protection. This should be an exciting week either way.

One of these times Apple will break the trend and won’t sell off. The strong fundamentals of this stock are based on its increasing rate of earnings per share that is being generated from market share gains of the iMac, iPhone, and iPad. Earnings growth is reason enough for the stock to go up. What makes the Apple story especially intriguing is the valuation.

Casual investors tend to think that the current price is high. Nothing could be further from the truth. From a valuation standpoint, this stock hasn’t been lower since Steve Jobs returned to the company more than ten years ago. The recession punished Apple by taking away its P/E multiple. If the market decides to return the Apple multiple back to its norms, it will cause Apple stock to receive a double whammy of improved earnings and an increasing multiple at the same time. Earnings per share of $14 in 2010, in addition to a p/e multiple of 25 brings us to a stock price of $350. Apple at $350 wouldn’t even be expensive. My definition of expensive would be a P/E multiple of 40.

Consider that Amazon (NASDAQ:AMZN) has a current P/E multiple of 63. Apple with a P/E multiple of 40 would equal a $560 stock price and if they got the Amazon 63 it would put Apple at $882. Will Apple get their cake (earnings expansion) and eat it too (multiple expansion)? We shall see. All I can say is that when Apple does go on its big run, our subscribers will be in position to make maximum profits. This is setting up to be the trade of the year.

Disclosure: Long aapl, qqqq