One of my readers actually commented that it was the first article he had seen by me that didn't hedge a position, and he was right.
Well, it's only been a short while and we've all seen AAPL climb nearly 100 points. Once again the commentary around AAPL is "two-headed" with both the bulls and bears vociferous. So, it seems like a good time to revisit the original recommendation.
As rationale for my initial recommendation I introduced a metric that I have been using, called Required Business Performance® (RBP) that was developed by Transparent Value Advisors and Dow Jones.
Though you should go to the website (where you must register) for full information, I'll repeat my interpretation of RBP. It is a valuation metric that attempts to predict the probability of a stock's price being fairly valued. So, rather than just saying "Buy, Hold or Sell," it provides a probability that the business model can support the current valuation. It looks at the various product lines and many other factors in reaching these conclusions.
At that time RBP gave AAPL a 99.06% probability of being fairly valued. Very few stocks could claim as positive a result and this played the largest part in my recommendation.
Part of my long only strategy included periodically monitoring the RBP metric and to consider "lightening up" when, and if, it became less favorable.
Well what does RBP tell us when AAPL is now at $542? The probability metric has actually increased to 99.85%! In light of this, I continue my bullish stance and continue to be long AAPL. As before, I will monitor the RBP for any indicated modification of my position and report back if it changes.
Let me now turn to the main reason why I think this particular metric is a valuable tool for investing.
Most of my investing strategies revolve around option utilization. With few exceptions, I prefer to sell puts rather than an outright buy of the underlying or even buying calls on the underlying.
The reason I prefer selling puts is quite simple. In order to profit, the underlying stock need only hold a price at, above or slightly below the initial strike price of the option. Inasmuch as I get to choose the strike price and expiry date, I can determine, in advance, the parameters that best fit my goals.
On the other hand, if were to simply buy the stock, it must move up to make money. Call options are subjected to time decay and were I to buy a call, it may take more than just a small upward move to make money.
Now, of course, an outright purchase of the stock or the call offers greater potential return on a sizeable run-up. The investor must choose which investing strategy best fits his or her temperament.
Though it is a matter of personal preference, I choose to go with the probability of profit over the potential magnitude of profit. This is especially true when the annualized return on most put selling, when profitable, is at least 10% and sometimes more than 50%.
Effective put selling is at its most profitable if one can predict the likelihood of the underlying holding a specific price. Stock and calls, on the other hand, are most profitable when one can accurately predict the "target" price of the underlying.
Now, traditional analyst opinions don't help put selling as much as they could. For instance, a traditional BUY recommendation strongly factors in the potential price appreciation. A stock that is likely to just "sit flat" or have modest growth, while perfect for put selling, wouldn't get a BUY recommendation.
Any metric that is sensitive to a stock holding its price can encourage put selling. As a result, it is pretty easy to see why RBP is such a good fit for put selling. In fact, for those who regularly use put selling as part of their portfolio strategy, I can't think of a more relevant metric.
This is especially true if the underlying starts to fall in price. A high RBP (such as 99%) gives a good indication that a rebound is likely. This is vital in calculating whether you need to close out or roll the position.
Now, the RBP won't tell you where the stock is headed and you need to bring other metrics into focus. These other metrics can help you determine the strike and expiry dates.
Unfortunately, parts of the Transparent Value Advisors website is for professionals only. I hope they liberalize this. But, don't despair, there is much information on this metric that is not restricted to professionals. Additionally, I will continue to update on AAPL's progress and also offer other "picks" for consideration in future articles.
Disclosure: I sell put options on AAPL. I am not affiliated with Transparent Value Advisors in any way.