Apple Headed For Pullback, Short Term Of Course

| About: Apple Inc. (AAPL)

I know from this title, many of you are going to think I am nuts. With the Apple (NASDAQ:AAPL) mania taking on a frenzy of late, there have not been many arguments presented of the stock being overvalued. I personally had a stake in Apple, and liquidated my positions about a week ago. Not because I do not believe in the company or its products, but I liked the ROI I would get from it AND did not like the way the stock was behaving in regards to its past history (which I will explain below).

Even though the price has risen a few more dollars since I bailed, I do not regret my decision. I am an investor not looking to fall in love with a stock but to make money. Plain and simple. That said, even though "Greed is good" remember, "Bulls make money, bears make money but pigs, they get slaughtered".

As I mentioned, I liquidated my position on the stock about a week ago. I love the company; among many things, I love the fact they can charge whatever they want for their products (today's announcement from Best Buy to drop the prices $50 on Ipad2 is so they can move inventory I would imagine and make room for the Ipad3) and are technologically superior to the competition. Plus they know how to market and know how to give their customers what they want and seemingly cannot live without. As an example, my iPad comes with me nearly every place I go (even to the bathroom!). I am sure I am not the only one who seemingly cannot live without it!

Now for the things I don't like, at least in the short term.

(Click to enlarge)

As you can see from the chart, the stock is trading on the high side of its Bollinger bands, which doesn't necessarily mean it is overpriced, but these trends do tend to signal a possible downturn. The upper as of today was around $538, the lower $439 so the price is right on the cusp of being in the traditional "sell" area.

You also have to keep in mind, Apple has grown almost 45% in less than 3 months. I know the financials and news has been all good, but it is possible a stock can grow too fast, even a monster like Apple? What about a pullback, is it possible?

Take a look at the chart below, Apple for the last year:

(Click to enlarge)

History tends to repeat itself in the market, even for an empire like Apple. As you can see, throughout Apple's impressive climb, there have been 2 double digit pullbacks from large gains in the last 6-8 months.

The stock (as of today 2-27) is up almost 45% since the last "dip" back in December. The stock has rode the great financials and news from December on to get to where it is today. So, what would my strategy be if I was still holding the stock (other than sell like I did)?

Let's say for example you own 200 shares of Apple, with a cost basis of $450 for easy math. You believe in the stock but you also believe what I am telling you about the pullback that historically has happened before. You could sell 2 March $550 covered calls against your 200 shares for a premium of $720 ($3.60 a share less fees). The expiration date is less than 3 weeks away. Why so soon? Cause we are expecting a "short-term" pullback, not long term and want to capitalize on that, not risk losing significant upside. If you feel Apple is overvalued and will pullback and remain there for longer term, then go further out than March and write more expensive covered calls and make more $$. You can also write covered calls closer to the current price for more money, but this example probably maximizes your profits while minimizing risk that your shares are called. Also remember, traditionally 75% of options purchased expire worthless when they are written on values that are not in the money.

So what can happen (I listed in my order of likelihood):

1) Price closes below $550 on March 17th, you pocket the $720.
2) Price goes just above $550 (would be another 5% in addition to the gains already with no pullback), your shares are called (for $20,000 profit) and you still keep the $720 as well.
3) Price jumps to $600 (in less than 3 weeks would need to jump ANOTHER 14% on top of what it has already) with no pull back you lose out on another $9,280 in profit (extra $50 a share - the $720 for covered calls).

Wouldn't you say option #1 or #2 is most likely to happen? And if the price goes down, or doesn't climb to $550 by March 17th, (again being a long you would have held anyhow) you still make the $720 for the options. I know $720 may not seem worth the bother, but if you believe in historical data, it is a no-brainer. It's also not that bad a ROI (over 1%, rounds out to 19% if you did over and over throughout the year) for less than a 3 week investment. And that is IF it jumps to $600.

I wrote another article on hedging against rapid growth when you deal with options, if you are really worried about option 3, then buy options longer and higher priced out as well as writing the covered calls. For example, you could purchase options that it would hit $620 in April for only $1.45 per share ($145 per option). Should you follow the strategy and the stock DOES jump to $600 by March, you would probably triple your money (or more) on the April options you purchased AND still make your $20K profit plus the premium for writing the covered calls. And if the price does not reach the $600 level, you still have a chance to reach your April strike date and still pocket the money for the March covered calls.

Although the recent news has been wonderful for holders (as I once was), as I have mentioned I believe based on the historical data there will be a slight pullback of maybe 10% in the coming weeks. You can still like Apple's prospects and potential for long term growth (as I do) but frankly I see a pullback to $500 before it hits $600 and beyond. This offers an opportunity to make money via covered calls and still be long on the stock.

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