Apple: A Better Buy Due to AT&T Acquiring T-Mobile

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Includes: AAPL, GOOG, T
by: Paul Zimbardo

This is the eighth article in a series on Apple (NASDAQ:AAPL) option strategy. Apple is a very unique company due its combination of size ($305B), earnings growth rate (75%), and volatility (1.4β). This presents an exceptional opportunity for investors to capitalize on both its long-term capital gain prospects and short-term option premiums. For reference, please view the first, second, third, fourth, fifth, sixth, and seventh articles in the series to fully understand the strategy and its strong potential returns.

A brief recap of this week in Apple [Down $23.12 (-6.5%)]:

  • iPhone 5 Rumored to Not Have NFC (The Independent Mar. 14)
    • "Deutsche Bank: Apple's Lead ‘Insurmountable’" (Apple Insider Mar. 14)
    • Apple’s "Halo" in Japan – Connecting Displaced Residents (Apple Insider Mar. 15)
    • Excellent Analysis of Recent Apple Upgrades and Downgrades (Forbes Mar. 17)
    • NFC Wallet Rumored Back (Forbes Mar. 17)
    • Five Key Components Impacted By Potential Delays (Apple Insider Mar. 18)

The media coverage of Apple the past week has centered on the impact of the earthquake/tsunami and analyst opinions regarding the iPad 2 launch. I will address the Japanese news first. The situation in Japan has only gotten worse as time passes. Now it is not a question of if Apple’s supply chain will be disrupted but a question of how much. I stand by my belief from my previous article: "Apple will likely face higher costs and larger delays, at least in the short-term. Apple is not alone facing these obstacles but should be better positioned than its rivals due to its long-term supply contracts.”

There is no denying that the disaster will impact Apple’s short-term earnings due to (a) lost sales, (b) higher costs, and (c) potential iPhone 5 delays. Despite these negative factors, as a long-term investor I do not see anything that will impair Apple as a going concern. On the contrary, the iPad shortage only makes the product more elusive. I highly doubt that potential consumers who were planning on buying an iPad will decide to by Motorola’s Xoom (NYSE:MMI) just because there is a month delay for an iPad.

I am generally a contrarian investor so I am always open to reading news that is contrary to my opinion so I was eager to read Guana’s comments. Unfortunately for Guana (JMP Securities), Reiner (Oppenheimer) logically refuted the position: "Oppenheimer's Yair Reiner pointed out Wednesday that Hon Hai -- which is dependent on other manufacturers for nearly 80% of its business -- is a lousy proxy for Apple." As I predicted last week, lesser known analysts have been authoring reports regarding Apple that are putting downward pressure on the stock. Let the investor beware!

The late-breaking news on Sunday is that AT&T (NYSE:T) will acquire T-Mobile for $39B – this will definitely have implications for Apple. My initial impressions are that this is good news for Apple as it could potentially provide access to an entirely new group of prospective customers. Only time will tell how many of T-Mobile’s 30 million customers purchase iPhones. There are still significant regulatory hurdles and "AT&T expects this transaction to take a year to go through the necessary approval process" so do not get overly optimistic.

Below I present three possible scenarios and the potential returns for the March 19 weekly options (Source: TD Ameritrade). The first scenario represents a very negative outlook for Apple the next week while the final two scenarios are more realistic in my opinion. As a general rule, selling calls with higher strike prices has more potential return but more risk of loss due to the lower (or lack of) downside protection. For more information on the fundamentals of covered calls, read this excellent article on Investopedia.

Scenario 1: AAPL Closes at $313.56 (Down 5%)

Strike

Price

Return

Return %

Annualized

Downside Protection

320

$13.20

($3.30)

-1.00%

-73.05%

3.05%

325

$9.45

($7.05)

-2.14%

-155.99%

1.53%

330

$6.50

($10.00)

-3.03%

-221.24%

0.02%

335

$3.80

($12.70)

-3.85%

-280.95%

N/A

340

$2.00

($14.50)

-4.39%

-320.77%

N/A

Click to enlarge

Scenario 2: AAPL Closes at $330.06 (Unchanged)

Strike

Price

Return

Return %

Annualized

Downside Protection

320

$13.20

$3.14

0.95%

69.45%

3.05%

325

$9.45

$4.39

1.33%

97.09%

1.53%

330

$6.50

$6.44

1.95%

142.43%

0.02%

335

$3.80

$3.80

1.15%

84.05%

N/A

340

$2.00

$2.00

0.61%

44.23%

N/A

Click to enlarge

Scenario 3: AAPL Closes at $337.5 (50 Day SMA)

Strike

Price

Return

Return %

Annualized

Downside Protection

320

$13.20

$3.14

0.95%

69.45%

3.05%

325

$9.45

$4.39

1.33%

97.09%

1.53%

330

$6.50

$6.44

1.95%

142.43%

0.02%

335

$3.80

$8.74

2.65%

193.30%

N/A

340

$2.00

$9.44

2.86%

208.79%

N/A

Click to enlarge

Additionally, if you would like even more information, I have prepared a sensitivity analysis for absolute return and percent returns, respectively. After studying the information above, these two charts make it easy to pick a strike price based on where you believe Apple will close on Friday.

Apple Option Sensitivity AnalysisClick to enlarge
(Click to enlarge)

Based upon the details presented above, I am of the opinion that executing a buy-write on AAPL and selling the Mar. 25 330s is the best strategy due to its risk-return profile. If you are uncomfortable with this level of risk, I would suggest utilizing the 325s. Conversely, to increase potential returns, the 335s may be a better choice for your individual strategy. With Apple down so significantly the past two weeks, if you are a long-term investor and reluctant to sell at these levels, I would avoid selling calls this week. I fully expect Apple to recover in 2011; therefore, the strategies presented above are more appropriate for traders and those without open Apple positions.

As many great SA users have pointed out, an alternative strategy is to sell out-of-the-money puts on Apple and collect the premium without having to purchase the stock outright. The 320s, 325s, and 330s are all attractive for this purpose. If I did not have an Apple position I would definitely consider selling these puts. Think about it: would you be willing to receive $4 to potentially be forced to buy Apple at $325? However, always remember that if the stock goes down to the strike price, there is the obligation to buy the stock (or close out the position).

Disclosure: Author holds long positions in AAPL, MMI, and T.