Time For Apple Longs To Take Profits?
A basic analysis of Apple would assume the following:
- Long term iPhone growth at 3% Apple free cash flow of $50 billion
- Free cash flow growing at 3% in line with iPhone unit sales (this assumes no margin compression)
- Required rate of return of 13%
Based on those metrics, Apple shares have a value of $95 per share [50 divided by (.13 -.3) = $500 billion or $95 per share. The current $140 per share is going to cause some nosebleeds, in my opinion.
It's understandable to wonder whether Apple's share price has gotten ahead of itself, given its run up year-to-date...
... particularly given that Apple is currently trading at Wall Street's consensus 12-month price target for it (via Nasdaq, below).
Portfolio Armor Still Bullish On Apple
The Portfolio Armor website, which bases its potential return calculations on price action and option market sentiment, is currently bullish on Apple, estimating a potential return of about 19% over the next sic months. That should be considered a high-end estimate though: historically, actual returns have averaged about 0.3x our site's potential return estimates.
It's worth remembering, too, as Horace Dediu points out here, that Apple shares have suffered 40% declines eight times over the last few decades.
So, Apple shareholders who are bullish and want to stay long, but are concerned about getting caught in a downpour, might want to consider buying an umbrella while it's still sunny out. We'll look at a couple ways of doing so below.
Umbrellas For Apple Longs
Here are two hedges for Apple longs, designed for those unwilling to risk declines of more than 14% over the next several months (you can use a different decline threshold if your risk tolerance is different). We scanned for these using the Portfolio Armor iOS app, but you can find them manually too, using the method laid out here. For a refresher on hedging terms, see the section titled "Refresher on Hedging Terms" here.
Uncapped Upside, Positive Cost
These were the optimal puts, as of Friday's close, to hedge 500 shares of Apple against a greater-than-14% decline between now and late October.
As you can see above, the cost here was $1,825, or 2.61% of position value. That cost was calculated conservatively though, using the ask price of the puts. You can often buy them for some price between the bid and ask, so you likely would have spent a little less than $1,825 on these puts on Friday. If you'd rather not pay anything to hedge, consider the collar below.
Capped Upside, Negative Cost
As of Friday's close, this was the optimal collar to hedge 500 shares of Apple against a greater-than-14% drop by late October while not capping your upside potential at less than 10% by then. 10% was the highest cap where we could wipe out the positive hedging cost.
As you can see above, the algorithm was able to use a less-expensive strike for the put leg of this collar than in the optimal puts above. That's a result of an iterative process taking into account the net cost of the hedge. The cost above was $1,275, or 1.82% of position value, calculated conservatively again.
As you can see below, though, the income generated from selling the call leg was higher: $1,650, or 2.36% of position value (also calculated conservatively).
So the net cost here was negative, meaning you would have collected $375, 0.54% of position value when opening this hedge, assuming you bought the puts at the ask and sold the calls at the bid. If you placed the trades within the spread, you would have collected more than $375.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.