The trend in Apple (NASDAQ:AAPL) shares has been pretty much unidirectional for the last year. However, it is hard to ignore that the move has especially gained pace in Q1 of 2012. As the stock has rocketed by almost 50% in less than three months, a good question to ask is who might have bought all those Apple shares rather than why they might have bought them. The question also gains importance considering Apple's size. One gets curious: Who has all that buying power to prop up a $450 billion market cap even higher?
Well, I might have the answer.
If you dig a little deep in to the options volume data in January and February 2012 (March 2012 isn't out yet) you'll realize that the options activity in Apple is highly skewed to the call side. However, the reason this matters is not because it suggests investors are hugely bullish on Apple. The real reason it matters has to do with option underwriters and market makers. Here is the deal:
Options need to be supplied to the market to meet demand from regular investors. So when you buy an option, it doesn't have to be from someone who bought that option before but decided to sell it. Chances are it will be an option newly created by a market maker. However, they don't sell you the option because they have a different opinion than you about the underlying security. These people are market makers, not speculators. They have to hedge almost all of their exposure. The way these people make money is when the options premium on the option they sell you erodes as the option gets closer to expiration. They don't make money because of the moves in the underlying, since they are almost always completely hedged.
So what does this have to do with the rise in Apple stock in Q1 2012. The thing is Apple's call-put differential was skewed to the call side by 700,000 contracts in January 2012 and 1,073,000 contracts in February 2012. The market makers have to hedge their exposure when they sell a call by buying up the shares (and vice versa with the puts) so that if the underlying security increases, they make up the loss on the call they are short with the long position in the underlying. Normally, the call and put volumes would be close to each other and the hedges would cancel each other out as well. However, in Apple's case, the option underwriters had to increase their Apple stock position by almost 170,000,000 shares to hedge their exposure because the balance was highly skewed to the call side. That is almost 17% of float in Apple.
The percentage of float figure above is very important as that is the main determinant of the upward pressure in shares. Some investors mistakenly conclude that it is the ratio of calls to puts that matter, which is not true. What pushes up the shares is how much of the float in the underlying the option underwriters have to buy to hedge their positions due to the call/put imbalance.
This argument makes sense in theory, but does the data support it? Well, the Apple bulls will have a laugh at this. The thing is, the alternative environment hasn't happened in Apple shares for a while, so it is rather hard to determine whether the theory is backed by the data. The fact of the matter is, Apple shares have never had a sustained decline of a month or more in the last year and a half. Also, the options volume has been skewed to the call side for almost all the months for that period. So there is no way to determine if an options volume skewed to the put side would have pressured the shares since that hasn't happened for a while in Apple.
One thing that supports the theory is that Apple has declined almost on all of the expiration dates in the last year and a half. And in most of those, the shares have rallied after the options expiration. That might suggest that as many options lost their value, underwriters were able to close out their hedges as expiration neared. Then they have to increase their hedges as investors buy up the calls in the next month's options.
I will try to analyze the applications of this theory to possible price developments in Apple in another article. However, suffice it to say, the options volume will probably come out skewed to the call side in March 2012 too.
The theory makes sense to me on the basis that option underwriters would definitely qualify as the influential players that have the buying power to push up a $450 billion market cap even further. What's your take?