Apple Euphoria Peaks - Time For Caution?

| About: Apple Inc. (AAPL)

Looking at Seeking Alpha's most popular articles, every week at least 20% of them are about Apple (NASDAQ:AAPL). It seems like a contest - who will predict a higher price for the stock. $800 seems like a done deal today. Many predict $1,000. Who is next? Do I hear $2,000?

I'm not going to join the contest. I admit that I simply have no idea where Apple will be trading and I don't want to look like a fool a year from now. One of the arguments is: "Analysts increased the price target for 2012." Does anyone still take those analysts seriously? You can read my article 'A Review Of 'Expert' 2011 Predictions' to see analysts' predictions for 2011. Most of them don't seem to know any better than any of us.

If I was really forced to give a prediction, I would say that the stock probably will be trading higher a year from now if the markets cooperate. But I would also bet that it will not reach $800 this year. $500 Billion companies don't double in value in one year. But if the markets go down hard, it is not difficult to see the stock going back to $350-$400 levels. In 2008, Apple went down 60%. You think it cannot happen again if the markets crash?

I really like reading articles written by fellow SA contributor Rocco Pendola. His articles are always fun to read and his approach is very realistic and down to earth. He wrote few days ago about Apple:

As hyped as I am about Apple's prospects going forward - as evidenced by my $600 LEAPS call - it might be time to temper the near-term enthusiasm. As such, I am going to enter some (not very bear) credit spreads, selling 10 AAPL March $500 calls for $3.90 and buying 10 AAPL March $510 calls for $2.52.

He was obviously too early on that trade, but I think this is the correct approach. As Rocco wrote few days later:

it's not crazy to think AAPL will pull back again. Investors could very easily "sell the news" when Apple reveals exactly when it will release iPad 3.

If I traded Apple, I would do the following trade today with the stock trading around $502.60:

  • Sell AAPL March 2012 520 call
  • Buy AAPL March 2012 525 call

You will get a credit of $1.50 per spread. Ten spreads will credit your account with $1,500. This is your maximum profit. Margin requirements for this trade are $3,500, so maximum return on margin is 43%. The maximum gain is realized if the stock stays below $520 by March 2012 expiration. Based on the short strike delta, the trade has a probability of 64% to expire below $520.

Of course if the stock rallies above $520, the trade will lose money. It will have to be adjusted or exited prior to March expiration.

If the stock pulls back 4-5%, I would place a bullish put spread with options 5-7% Out Of The money, converting the 520/525 spread to an Iron Condor. The trade will not require any additional margin since both spreads cannot be In The Money at the same time.

The trade can be partially protected with a Reverse Iron Condor using weekly options.

For example, using this week's options, you can place the following trade:

  • Sell AAPL February 2012 495 put
  • Buy AAPL February 2012 500 put
  • Buy AAPL February 2012 505 call
  • Sell AAPL February 2012 510 call

The maximum profit is realized if Apple is above $510 or below $495. It requires just 1.5% movement in either direction by the end of the week. The idea is to use the short-term volatility of the stock to make gains with the Reverse Iron Condor. There is a good chance for the stock to move 1.5-2% in one week, but it is not very likely that it will continue in the same direction week after week. No stock moves in a straight line. Not even Apple.

If you decide to take this trade, it might be worth it to wait till Thursday and use the next week weekly options. It will give the stock more time to move.

Being bullish is one thing. Being blindly bullish is completely different. No stock goes up in a straight line.

I remember a similar euphoria five years ago. It was about Google (NASDAQ:GOOG). People predicted that the stock will double every year. There is no need to say that Google is trading now lower than four years ago.

Of course many people will argue that Apple is not Google. They might be right or wrong, nobody knows. We don't even know how the technology world will look five years from now.

The four most dangerous words in finance are "this time is different." -- Carmen Reinhart and Kenneth Rogoff

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.