The major point of this article is to explain my reasons for believing that Apple (AAPL), right now, this week, may be the best investment opportunity that we have seen for many years, and how to best play it with options.
But first, I feel compelled to comment on a fellow Seeking Alpha contributor's article entitled "There Are No Strategies For Making Extraordinary Returns With Apple Options" by Epsilon Options (see it here). He was refuting my earlier article entitled, "2 Strategies For Making Extraordinary Returns With Apple Options" and its supporting report, "How We Made 357% (After Commissions) With Calendar Spreads on AAPL in the Summer of 2012 While the Stock Rose Only 13.3%."
I was delighted to read his article because, as one sage put it, "There is nothing quite so satisfying as accomplishing something that someone says is impossible." As I write this (end of day, September 5), another week and a half has gone by since the end of that record, and the portfolio has now gained 428% (even though AAPL fell $4.74 today). Is 428% in six weeks considered "extraordinary?" Maybe not. But it isn't exactly shabby, either.
The big reason for his thinking that an extraordinary AAPL options strategy does not exist apparently has something to do with implied volatility (IV) of the option prices. I am not a big fan of making option investment decisions on the basis of IVs. If I were, I would never have bought a single one of those AAPL calendar spreads. The IVs of every successive month for AAPL are higher than the shorter-term month they follow. In other words, it is impossible to buy a calendar spread with AAPL options using any months whatsoever and enjoy an IV advantage. Every long option you buy is more expensive by the IV measure than the option you are selling. This is particularly true for the Weeklys that I sold in my actual portfolio.
Each day, I read every article I can find that has to do with AAPL and options, and some of the articles are good for my chuckle of the day, far more fun that the local newspaper comic section (yes, I actually read such a dinosaur -- it gives you an idea of how old I am). Several have suggested doing searches for IV advantages and selling naked out-of-the-money puts or calls on AAPL. In my opinion, that is one of the most foolish ideas imaginable. First, you have to post a huge margin requirement, tying up so much money that your maximum return on investment is so small to be hardly measurable.
Second, and more importantly, you are exposing yourself to unlimited losses on the upside (with calls) or potentially devastating losses on the downside (with puts). Several times, AAPL has moved more than $100 in less than two months. That $50-out-of-the-money put you sold for $2 would net you a maximum of $200 if the stock behaved itself, but could result in a $5,000 loss if the stocked tanked as it did after the April earnings announcement. Selling naked options of any sort on AAPL makes absolutely no sense to me. Regardless of what the IVs might tell you
Several people wrote in after my article and said if I believed that AAPL would move higher, why wouldn't I just buy a call? While this makes a little more sense to me than selling a naked short, to my way of thinking, it is not much better. If you buy an at-the-money call, the stock must go up by the amount of that call before you make a nickel, and if the stock is flat or falls, you lose every cent you invested. Some studies have reported that 70% - 80% of all options eventually expire worthless. People who bought those options presumably lost 100% of their money. Those don't sound like very good odds to me. Probably a lot better than buying a lottery ticket, but not a whole lot better.
In my earlier article, I suggested buying a vertical spread on AAPL in a six-month-out expiration, paying about $25 ($2,500) for the Feb-13 635 - 685 call spread when the stock was trading at $663. This spread takes advantage of the fact that for the last 3½ years, AAPL has always been higher at the end of a six month period than it was at the beginning of that period, regardless of which dates you select.
If, on January February 15, 2013, AAPL has gone up at least $22 (3.3%), you would double your money with this spread. And if the stock does not go up a penny (something it has not done over six months for more than three years), you would still make a small gain ($300 less commissions).
If you wanted to buy a call option that expired in Feb-13 and spend only $2,500, you would have to select the 725 strike. The stock would have to go up $62 before your option had any intrinsic value. If it rose less than $62 (9.4%), you would lose 100% of your money. You would only start making a profit when the stock had gone up over $750, or $87 higher than it is now.
The Current Situation In AAPL
I read every article on Seeking Alpha that features AAPL. It is my favorite underlying (although more of my portfolios trade options on SPY). I love the research on the various products and prospects for AAPL. I especially like the articles written by people who are short the stock -- if there weren't people like them out there, there would be no stopping this stock from moving too high too fast.
While it's impossible to really know if Apple will announce the iPhone 5 on September 12 as the rumor suggests, I think there is a fairly high likelihood that a new phone will be on the shelves before the Christmas buying season. From all reports, it will be a raging success. Apparently, millions of people have postponed buying current iPhone models while they wait for the iPhone 5. One Seeking Alpha article said that a survey of iPhone users indicated that 94% would be buying an iPhone when their current mobile phone needed replacing. Since most users sign up for a two-year contract with their carrier, and the iPhone 5 was not released a year ago when it was first expected to be launched, there is probably a huge pent-up demand lurking out there.
Last February and again in May, China Mobile, the largest (by far) mobile phone company in the world, said it was in talks with Apple. Unfortunately, the iPhone 4S could not be used with China Mobile's technology, so an agreement could not be reached with Apple until a new model came available. Can you imagine why two such huge companies would not agree to work with each other? The potential profit for both companies would be staggering.
If an agreement with China Mobile is announced next week (or whenever the iPhone 5 eventually hits the market), Apple's biggest challenge will be making phones fast enough to meet the Chinese demand alone. (It took them several months to catch up with the demand when a company less than one-third the size of China Mobile was offering an iPhone.) Forbes Magazine published an article stating that a China Mobile - Apple agreement would result in an $800 price for AAPL.
One of Apple's major suppliers announced that they would be expanding their manufacturing capability with an investment of $50 million in the 4th quarter of 2012. Why do you suppose they would be doing this if it weren't for the iPhone 5?
There are other potential developments at Apple that could dramatically increase sales in the near future, although the company might be reluctant to introduce them until they get an idea of how difficult it will be to meet demand for the iPhone 5, especially if China Mobile is on board. The wireless mobile phone payment system (now so popular in Europe) and the Apple TV product are two possible introductions that could change the world as we know it, all to AAPL's benefit. A third is what would happen if they split the stock -- it would then probably be added to the Dow Jones Industrial Average, many more mutual funds would be forced to buy it, and the stock would soar. It is almost scary.
So where do we stand with AAPL right now? The company is selling about at a cash-adjusted P/E of about 12 while it is growing at a rate north of 25% a year, is paying a dividend, and has liquid options with small bid-ask spreads (tell me about one other company with such numbers and I'll send you a free copy of my latest book by first class mail). The only reason to believe that the stock could fall in price is that the market believes the growth rate cannot be continued into the future (the company is just too big, the pundits argue).
However, from every indication that we have right now, the next two quarters will probably result in extremely higher than 25% growth thanks to the iPhone that is on its way. That means if the P/E ratio remains at its extremely low (compared to the S&P 500 average) level, the stock must surely move higher over the next six months. After that time, it is anyone's guess as to what will happen.
So what do we do if we believe there is a high likelihood that AAPL will be at a higher price six months than it is today? In my opinion, you should look no further than the options (the stock is too darn expensive for most of us, anyway). The vertical spread I spoke about above should yield a 100% gain in six months as a starter.
Many years ago I read a book with the intriguing title, "Happiness is a Stock Which Doubles in One Year." What word could replace "Happiness" if the time period was six months rather than a year? Ecstasy? Nirvana? I don't know what the right word might be, but I have a ton of my own money already invested in vertical spreads that expire in January 2013, and for many of them, I will double my money by that time even if the stock were to fall by over $60 from where it is right now. It is a nice feeling.
I think it is unlikely that there has been a similar opportunity to this one in the last decade (okay, I did recommend an options-related stock purchase to my subscribers last October, the only stock recommendation I had made in 11 years, and the stock is now more than double what it was then, and I have recommended selling it at the current level -- but that was an exception, and did not have the degree of certainty that I believe the AAPL situation has right now).
An alternative to a six-month-out vertical spread, a potentially greater gain might be made with a selection of calendar spreads on AAPL, but that is the subject of another article.
By the way, in the interest of full disclosure to the statement below, I don't have a business relationship with Apple, but my wife owns a Mac, and we both have iPhones and iPads. I suspect that Tim Cook does not know about our purchases.
Disclosure: I am long AAPL.