Apple Now A Good Buy, As Indicated By Market-Maker Hedging Actions

| About: Apple Inc. (AAPL)

In a previous article entitled Behavioral Analysis of Coming Facebook Prices, we used Apple as an illustration of how well the market-making community of block-trade transaction facilitators and their cohorts-- the proprietary trading desks-- could anticipate coming price movements in actively-traded stocks. Reference to that article will provide support and understanding to our following comments about the near-term outlook for Apple prices.

Based on closing quotes for AAPL stock and its listed options on Friday, June 8th, the market pros' bets were that buying risk protection (for shorts) above $656 and below $563 (on long positions) were not good gambles (for them). Keep in mind that these every-day market sophisticates have resources at their disposal not readily available to ordinary investors. They continuously practice at using them on their cannibalistic brethren. Survival of the fittest is order-of-the-day. They are not always right, but they work assiduously to sharpen their sense of the odds in every situation, every day, and every stock involvement. It's not easy, because the circumstances are always shifting. What results is an art form, like in many competitive activities.

Their price forecasts are embedded in what they (block desks) are willing to pay to hedge at-risk stub ends of blocks the market won't immediately absorb (so the facilitator must temporarily own or be short) to complete a volume transaction, under time pressure, for a big-money client. The other side of the protection transaction comes from what (the prop trade desks at) other houses demand to take on that risk. Both sides are intent on being as well-informed as is possible of potential changes in the situation of the underlying investment. In many ways, the price insurance market is more sophisticated and can be better-informed than the market for the original investment.

At any rate, those forecasts are continuously being revised, sometimes shifting faster, or slower, than the stock's price. The relationship of the stock price to the forecast range is our expectations-equivalent to the P/E ratio. We call it the Range Index. So the starting point of the value analysis is the forecast price range (indicated earlier for AAPL as $563 to $656) and the current price ($580), produces a Range Index of 18. That's because 580 is 18% of the way up from 563 to 656.

Now, from the Behavioral Analysis article, please check out the odds for higher prices in the next 3 months for AAPL, when its RI has been no higher than 18. That's right-- it's about 75%, actually happening 76% of the 63 next market days following each of the 111 forecast days in question. So, what about that other 24%? How bad might an Apple buyer get hurt in the next 3 months, and what gain might be offered to a buyer if he took on that risk? The second picture in the other article tells that story.

The 18 Range Index level of that graph indicates an average of gain days at +13% above the forecast day, and average drawdowns from the forecast-day price, of -6%. So, here's a situation where three out of four day-blind liquidations would reasonably be expected to earn a profit of more than twice what the fourth one lost. Kindergarten calculation of (13+13+13-6)/4 = +8 ¼%. This is, roughly, what is shown in the other article's 3rd graph at the 18 RI intersection. Not bad, if the stock simply does what it has in the past, after having prior forecasts of this kind. And in comparison to the past 3 month experience of the S&P 500 (1325/1365 -1 = -3%) it looks rather good.

But as they say on the TV ads-- wait, it gets better. If one can identify those points in time where the ODDS are favorable and the PAYOFFS risks are minimal, then the possibility exists to use Time-Efficient Investing to opportunistically leverage one's RATE of return on investment capital. Just as an example of what might be done, not necessarily a suggestion of the best possible (whatever that may mean to you - as different from me) combination of choices, consider the following:

If one had bought AAPL every time its Range Index was at or below 18 in the past 6 years, set the top of the forecast range each time as the sell target for that buy, and closed out every position when the end of day price was at or above the target, or after 2 months (42 market days) had passed, 7.1% gains could have been captured in average holding periods of six weeks each. The capital cumulatively committed would have earned at a +76% annual RATE instead of the otherwise enviable 47% annual RATE that a buy-and-hold achieved. Please remember, this is just an illustration, not a challenge.

The important points are:

  • Well-informed investment professionals are behaving as though far better than average opportunities to buy AAPL are present now, and
  • The market pros regularly (involuntarily) demonstrate their ability to identify such points in time, and
  • Our use of their insights to employ time-efficient investment practices can provide a considerable advantage over most conventional buy-and-hold investment procedures.

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