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Kamil Kolacek
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Individual Investor with a background in economics and finance. Currently lives and works in the San Francisco Bay Area for a major healthcare organization. Interested in value investing, dividend stocks, technology, retirement strategy and macroeconomics. Eastern European Czech-born, but... More
  • A Conservative, Options-Based Strategy For Investing In Apple

    The purpose of this article is to share my strategy for investing in AAPL in what could be considered a relatively conservative long-term options-based approach. First of all, I will not extensively re-hash the myriad of reasoning's for either a bullish or bearish case on Apple since they have all been fiercely argued here on SA by previous authors.

    Yet, since my options strategy is based upon a price appreciation of Apple shares over time it follows that I have a positive long-term outlook on the companies shares and I will attempt to briefly outline my bullish reasoning before explaining the tactical options investing strategy.

    Briefly, my optimistic outlook on the firm stems from the commonly argued valuation standpoint as well as the fact that it is still one of the most innovative companies in the world. The death of its visionary founder and a few years of existing product enhancement cycles vs new revolutionary product introductions, has not suddenly transformed Apple from a growth company and leading innovator to a stagnate oversized tech company along the lines of Microsoft.

    Though the historic (and I would argue, unsustainable) earnings growth and gross margins following the launches of the iPhone and iPad product categories are indeed slowing, Apple still maintains industry leading margins and earnings power. Coupled with a highly irrational low market valuation, I believe it is only a matter of time before the market realizes it has placed an unfair valuation on the firm and will work to correct it.

    Looking at forward earnings estimates for 2014 based on EPS data projected by Zacks Research, we can conservatively quantify and model a whole spectrum of low valuations for the year. With Apple recently trading at about $530 a share and assuming a very conservative $41 in full year 2014 earnings per share, AAPL is priced at less than a 13 PE. If we are to back out the almost $159b in cash and cash equivalents on hand then Apple trades at a very conservative 8.5x 2014 earnings.

    Apple 2014 FPE

    Should Apple fall to various levels seen last year such as $500, $450, and $400 a share, the valuation figures become even more extreme. I would welcome owning further shares at any of those levels and as a result, have an options strategy to take advantage of such attractive valuations.

    My current investing strategy involves selling cash-secured, long-dated (LEAPS), out-of-the-money puts on Apple common. This strategy is quite conservative in that I recommend selling the puts cash-secured so in the event of assignment you have the capital to purchase the equivalent shares contracted. Also since the put strikes recommended are all below the current market price, a cushion and margin-of-safety is established. I use as examples selling puts at the $500, $450, and $400 strikes.

    The primary downsides to this strategy are that it takes both a relatively large amount of capital and a good amount of patience to implement. For example, for each put you sell at the $500 strike price you would have to maintain $50,000 cash in order to secure purchase of 100 AAPL shares should you be exercised at or near expiry. $45,000 & $40,000 cash would need to be on hand to exercise 1 contract on the $450 and $400 strikes respectively.

    Below is a table depicting these 3 out-of-the-money strike prices for January 2015 puts along with their associated premiums, dividend income and total yield (put premium + dividend). Without any price appreciation or margin built in, one could obtain 5-10% returns on Apple shares at forward price-earnings ratios ranging from 10.6 FPE to 5.4 FPE.


    Even if you believe Apple's best days are behind it and that it will cease to be a leader in consumer product innovation, these valuations already reflect such pessimistic views and provide a margin-of-safety for the shares. Unless earnings suddenly drop off of a cliff, Apple stops innovating and introducing new products, and gross margins crater, you will be obtaining a tremendous consumer product technology company at very reasonable levels.

    Although you are not guaranteed your principle with any equity investment, compare the 5 -10% annual returns (with no leverage) of this strategy to the current 5-year and 10-year Treasury rates of 1.58% and 2.70% respectively. With no price appreciation what so ever and a built in margin-of-safety of $69, $99, and $138 per share from the $500, $450, and $400 put strikes when including the option premiums, you are obtaining solid annual returns for a very conservative equity options based strategy. Factor in the attractive valuations should you be assigned and a current dividend yield of 2.30%, one would be hard-pressed to find too many other conservative individual equity investments as alluring as this one. Should you be assigned shares, you could then earn further income by selling out-of-the money calls on your position.

    With this strategy you make money even if Apple continues to trade sideways as it has in the recent past. If selling the deep out-of-the money January 2015 $400 strikes you will still profit should Apple fall up to $138 a share, or 26%! That is quite the large cushion. At $400 a share AAPL would then be trading at a 5.4 PE based on the lowest, most conservative 2014 EPS estimate by Zacks.

    Conclusion: If you are generally still bullish on this leading tech company and believe that the firm will continue to introduce new, exciting and profitable products into the global marketplace, and you have the available cash and patience, then you might want to examine selling January 2015 (or 2016) out-of-the-money cash-secured puts on Steve Jobs iconic company to generate income.

    Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Additional disclosure: I am long AAPL common as well as short AAPL puts.

    Mar 18 4:13 PM | Link | Comment!
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