Seeking Alpha
Long/short equity, value, contrarian, special situations
Profile| Send Message|
( followers)  

Since Apple (NASDAQ:AAPL) reported their stellar earnings back on January 25th the stock has soared from $422/share to a recent high of $526/share. That is almost a 25% increase in the stock's price in just 1 month. Apple is a fantastic stock that is still trading quite cheaply compared to its peers. The guidance that Apple provided during the conference call in January indicated that the company expects revenue of about $32.5 billion with diluted EPS of about $8.50. That suggests that Apple even with a $500 price tag is trading at just 14.7X earnings. Compared to Google (NASDAQ:GOOG) whose is trading for around 20X earnings and has a comparable balance sheet, Apple is a real steal at this price.

As for future growth I see nothing but continued upside for this company. Whether that continued growth comes from the iPod, iPad, iPhone, or rumored iTV their customer base continues to grow. With Apple now selling all of their mobile products on both of the nation's largest networks, Verizon (NYSE:VZ) and AT&T (NYSE:T), it is no wonder that they continue to exceed their quarterly expectations. I also believe that in the coming year Apple will continue to pick up even more market share from the business community as more and more business people trade in their blackberries for iPhones, myself included. I feel that this is already being reflected in the recent share price of Research in Motion (RIMM).

Apple has been extremely successful at being able to market itself as the leader of streamlined gadgets, as well as creating a cult-like following that will buy their products regardless. This in turn has helped Apple not only provide value to their shareholders, but has also provided the company with rock solid financials. The company currently has $97.6 billion on the balance sheet in cash, which makes up almost $105/share of their current $500 share price.

Even that being so, I still always like to be able to buy a stock for a deal, regardless of how strong the company may seem. Considering the recent volatility seen in the stock it would not surprise me to see this volatility continue in the coming weeks and for Apple to pullback a bit.

When that happens I would suggest selling some covered put options on the stock at a strike price that seems appealing to potentially buy the stock at. In my opinion the best way to execute this trade would be to sell the July 2012 $430 Puts for $13.30 per put option contract. This trade allows you to continue to capitalize in any upward movement in the stock, while allowing the trader to get paid while they wait for the stock to pull back to its pre January 25th pricing. This strategy will work for any strike price below $500 where the trader wouldn't mind buying the stock. I picked $430 because that seems to be current support level and if volatility continues that level might provide a bit of cushion if the stock starts to move down. This strategy also provides the trader with some limited downside protection if the trader actually has to buy the stock at the strike price the options were sold at. The $13.30 that is credited to the trade's account essentially makes the real breakeven point of the trade $416.70/share ($430 - $13.30).

Selling covered puts does involve some risk, but if managed appropriately it can provide a nice return and allow the investor the ability to pick their entry point (via the strike price), especially during times of unusual volatility. Selling puts at the $430 strike price obligates you to purchase the stock at that price for the equivalent number of put option contracts that were sold (1 contract = 100 shares of stock). At expiration of the option contract if Apple is at or below $430 the seller will be obligated to buy shares at that price. If this happens the seller is still able to keep the premium that was received for selling the puts originally. That premium will further help defer the initial cost of buying the stock. If the stock price is above your strike price at expiration the contract(s) will expire worthless and the seller gets to keep the premium that they received originally for selling the puts.

This strategy of waiting for Apple to come to your price point has three potential outcomes, all of which in my opinion are acceptable considering the risk/reward of the trade.

  • The stock increases in value and continues to move above the $500 per share level between now and July 20th, 2012 (Expiration of the July contract). Your put contract expires worthless and the $13.30 that was collected for doing the trade is kept.
  • The stock pulls back and goes below the $430/share level between now and July 20th 2012. If this happens the trader will be obligated to buy the stock for $430/share. Keeping in mind that the trader still gets to keep the $13.30 that was collected, so the real breakeven is $416.70.
  • The stock does nothing between now and July 20th 2012. In this situation the put contract would expire worthless and the trader would keep the $13.30 that was originally collected.

I really like Apple from a pure fundamentally basis, but I also feel that the volatility recently seen in the price is not sustainable and I am expecting a bit of a pull back. If this happens I want to be in a position where I can capitalize on that movement while picking up this fantastic stock at a discount from its current price. Bottom line, I think that there is a lot of opportunity in this stock from an option trader's perspective and selling covered puts is a very prudent approach in trying to capitalize on it.

Source: Using Options To Find A Better Entry Price In Apple