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While everyone is scratching their head regarding Apple's (NASDAQ:AAPL) massive P/E compression, the options market isn't. In the past 4 years, Apple's P/E has dropped from the 40's to a recent low of 12. This has taken place despite their extraordinary earnings growth -- which is actually easier to dismiss than accept due to its astonishing rate. The options market holds the answer in our P/E to growth deficit. I will put up a few recent examples, as these should be fresh in readers' minds.

Exhibit A:

The day is 11/30/11. The S&P 500 is up as high as 5%, whereas Apple gained a mere 2.4% at its highest point. I thought Apple was a high flyer, high beta stock? What happened? The options market is what happened. Let's look at the open interest (OI) for the weekly options going into 11/30/11 trading session.


(Click to enlarge)

Notice the highest call OI was on the $380 strike. It would not be in the best interest for option writers to have Apple go above this level. Now let's see what the trading day looked like. The bar chart is of AAPL with the S&P 500 superimposed in purple. The horizontal white line is the $380 level.


(Click to enlarge)

Coincidence? Or is the options market controlling Apple? Conspiracies are not conspiracies when they are routinely witnessed.

Exhibit B:

For the Apple bears I will show an example in your favor too. Below is my open interest graph from 12/08/11. Notice $385 is your highest OI put strike. Option writers would not benefit if Apple falls below this level.


(Click to enlarge)

Here is the trading chart for 12/08/11. On this day, the S&P 500 finished down 2.2% and AAPL closed with a $1.57 gain. AAPL is the bar chart, S&P 500 is in purple, and the white horizontal line is the $385 level. (Ignore yellow line, could not remove)


(Click to enlarge)

So within 1 week of Apple underperforming the S&P 500 by 2.5%, it is now outperforming it by 2.5%. Why did Apple not follow the S&P down? What was the highest put OI on the day? So Apple just happened to bounce from $385 and work its way back into the option writers "safe" zone of $390. That's pretty convenient.

Exhibit C:

A day in the life of an Apple options expiration. Apple's trading range for Friday (12/09/11) was $391.03 - $394.04. The highest volume for the day was on the $395 strike for calls and $390 strike for puts. They both traded ~30,000 contracts. As an option writer you would benefit from Apple expiring between $390 and $395. Anywhere in the middle will leave you 100% profitable. Apple closed $393.62. Below is a graph of what the out-of-the-money OI looked like after the market closed. You will not find this data on yahoo finance or any conventional option chain. This is what actually expired completely worthless. The purple sphere represents AAPL's stock price.


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I'm sure you have seen enough graphs, so I will forgo one with this example. Last week's option expiry (12/03/11) had a similar outcome. The S&P 500 was up 1.1% on the day while Apple finished 0.45% higher. The day's trading range was $388.58 - $393.63 with a quick drop to $389.70 at the end of the trading day. The highest volume traded on the $390 strike for both puts and calls. There were ~40,000 contracts on each strike. So again, Apple just happened to drop right into the area where option writers are most profitable.

I have only shown a few samples of what I have noted for the past 5 years. Taking the 12/03/11 example, was Apple supposed to close $395? If Apple takes a $5 dive every Friday -- yet earnings are piling up by the minute -- why wouldn't the P/E compress? Not to mention the few trading days a week Apple get's beat down from the call OI. The typical week goes something like this: Monday-Tuesday Apple gets to run free, Wednesday it settles down, and Thursday-Friday gets put in its place. Apple always has more call OI than put. This is the reason the stock will stall for 3 months, then go on a massive $50 run.

Conclusion:

If Apple's earnings are increasing rapidly, but you constantly have option pressure holding the stock price down, your P/E will compress. It makes it much easier once you know the ‘why’ in "why is Apple not performing." Don't listen to the production rumors, etc. Apple is trading 16 cents on the dollar for option related reasons. Nothing more.

As long as you have options controlling Apple, you will never have real price discovery or true value unlocked.

(Note: The affect on stock price when options are closed was not discussed. The above article falls into my open interest Max Pain theory. It uses the basis of the original Max Pain theory. In my studies of the original I noted its weakness for trading. I have morphed the original into a new high probability trading theory using open interest. I call it OI/Max Pain. It does not use dollar value nor an exact strike, but a range and OI.)

Source: Apple's P/E Compression: Options Have It All 'Under' Control