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AAPL to $100 in 98 Days

|Includes: Apple Inc. (AAPL)
Call me pessimistic, but when I look around I see a lot of negative economic data points. Unemployment still remains well north of 9%. Consumer confidence fell 10 points to 52.9 in June. European sovereign debt issues are cataclysmic and persisting. There is talk of deflation, a new normal, and heading into a double dip recession. Barrons ran a story this weekend on the impending “death cross” between the S&P’s 50 and 200 DMAs. With all of this uncertainty, it might seem logical that Apple (NGS:AAPL) could in fact be $100 in about three months..

But before you jump to attack me, I do not actually believe this doom prediction. I find it illogical in fact. A bit preposterous even. I think it would be a sign that the world has largely stopped functioning. Which is why I’m placing a (relatively) large bet that it won’t happen..

With any investment, return is directly commensurate to risk. At least it is supposed to be.. From my perspective though, a 60% short-term “correction” seems fairly low on the overall risk spectrum. Yet the market seems to be painting a very very different picture. Despite a young investment career, I have been fortunate enough to learn the market’s most important lesson: don’t have an ego when investing. When you’re wrong, you were wrong; when you’re right, you got lucky. The market is a collection of wisdom from people much smarter than me and with the prospect of a 20%+ annualized return for exactly that unlikely event, the market is clearly telling me I’m wrong. So either the market is right (as it usually is) and AAPL is about to undergo an “unannounced” 5:2 split, or I am about to get very lucky..

“When we are absolutely certain, whether of our worth or worthlessness, we are almost impervious to fear.”
-- William Congreve

Almost impervious.

I was actually going to write this article a few weeks ago when the VIX spiked. I opened the position, and it began working.. much faster than expected though.. and I closed the trade after a few weeks with an ~85% annualized return.. but I never had time to finish writing the article. Now it seems as if I have another chance. This article is not an investment recommendation. I am simply writing to explain what I am doing with my own money. The strategy involves the sale of uncovered or “naked” put options and my concept of “essential worthlessness” in option pricing. The annual return is based on the return relative to the maintenance requirement. I view this as my true opportunity cost.

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Apple - The Company

Apple is the largest technology company in the world. It makes computers, mobile phones, music players and a couple of other products. It is really good at what it does. I am not an Apple “fanboy”.. I am not blind to the company’s faults.. but as a technology person I have had a long appreciation for its products and innovation. It is an absolutely polarizing company. People seem to irrationally dislike it for a variety of reasons until they fall in love with it. It makes tech products in highly competitive markets. But it makes them sexy-like. It is the largest tech company in the world yet it has maybe 50 SKUs. How many other companies can say this? Apple doesn’t bend to you.. you submit to Apple.. and most people are very happy once they do. My dad just switched to a mac laptop. My mom just bought an iPad. They are the “sheep” Apple’s naysayers complain about.. but they are happy sheep. While Apple has always been the underdog, baby boomer and institutional acceptance is just beginning – and these are the target demographics with wealth & discretionary income.

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There are two ways to do equity analysis: fundamental or technical. I am not going to attempt to write about either in much depth, but I think it’s important to at least look at both.

AAPL – Fundamentals

I could try to talk until I was blue in the face about Apple’s strong history of sales and earnings growth. The increase in global demand for technology. The change in the iPhone’s subscription revenue model that was misunderstood by the street for the past two years. The long term outlook for touch technology. The company’s asset light business model that generates substantial P&L leverage. A pristine balance sheet with $40bE of cash on hand. Etc. Etc. But I won’t. I am going to keep this incredibly simple: people much more knowledgeable than me write on AAPL all the time - the stock currently has 47 sell-side analysts! Earnings for the current FY’10E (Sep) are estimated to be $13.75. Earnings for next year FY’11E (Sep) are estimated to be approximately $16.25. And for the 14 brave souls willing to publish estimates for FY’12E (Sep) earnings are expected to be $19.00. Even if they are horribly wrong (say by 50%, or $8.13) then at $100 the stock would still only be trading at 12.5x FY’11 “EPS”. And if you want to exclude the nearly $40 of cash/share this equates to less than 7.5x FY’11 “EPS”. “EPS” estimates that are half of current consensus. Oh yes and remember, this needs to happen in the next three months.

AAPL – Technicals

Let me be upfront, I’m not really a technicals person. Most of the time (current environment excluded) I try to believe that technicals follow fundamentals.. which I think is pretty much the cardinal sin of technical trading. I don’t use any charting software. I only learned about momentum in physics class. But I do believe technicals are important – particularly for market psychology. And I do think every trade should at least try to capture the potential impact of that. But most of them are fairly short term. Short term like intraday.. which given my firm’s P/A trading guidelines is just not my thing (regardless of my views). This is probably a 3-6 month trade. A change in the VIX or a bad news item and it could easily be an unrealized loss for a while.. but it’s a bet against the clock.

The one technical device that I’ll take a closer look at is a Fibonacci Retracement. Leonardo Fibonacci.. a brilliant Italian mathematician not dare to be confused with the “Fabulous” Fab. His simple series of numbers creates ratios that imprecisely describe the natural proportion of things in the universe.. mind blown yet? It describes things like the length of the forearm to the hand.. or the distribution of seeds in a sunflower.. or more importantly.. support and resistance lines in equity securities. Anyway the retracements are formed by measuring the ratio of a Fibonacci number to another Fibonacci number ‘x’ units away. As these approach a limit they are referred to as “golden” ratios. If I look at a chart choosing June 1st 2007 as a starting date (approximately represents the time of the announced launch date for original iPhone) AAPL has a local minimum of ~$80 and a maximum of ~$275. Excluding the 75% “retracement” because it is not an actual Fibonacci ratio, “death” in this exercise is a fourth order retracement. This is when the maintenance requirements start to rapidly spiral upwards (under $120). As I said before, this article is not an investment recommendation. I always try to make sure I am conservative enough to have room on my maintenance requirements to avoid a margin call. So far, knock wood.

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The Trade – Profit/Risk Analysis

This trade is not without risk. There are all the macro risks I alluded to in the opening paragraph. There is the health of Steve Jobs. The way the company tries to game its earnings.  Concerns with enterprise spending. US consumer credit. Competition. Acquisition risk (with $40b of cash). I think every single one of these along with probably a hundred others are all real viable risks. I think AAPL’s stock is debatably ahead of itself at current price levels and there is a lot of general market risk due to indiscriminate ETF sell offs. But I would load up the truck at $100. I included a couple of different put options in the attached chart. The time to my term “essential worthlessness” is primarily just based on a spot curve of previous option chains. The one I’m focused on in particular is the Jan ’11 $100 put. It currently has a bid/ask of $0.75/$0.81. I think this makes it up more than a few hundred percent from where it was before the flash crash. Regardless, the Oct ’10 $100 put has a bid/ask of $0.15/$0.17. So if all stays the same in 98 days I could cover at ~$0.15 and net a return of ~6% relative to the required maintenance. This is roughly a 22% annualized return against whatever else I could be doing with my money.

 

If I wanted to be more market neutral I could try and do some type of hedge by buying the VXX to offset any change based on volatility but I’m not interested in making this a pure alpha trade. If the market is unwilling to accept my definition of “worthless” in three months I’ll probably just hold them until closer to expiration.. bottom line is the market seems to be pricing in a high probability for a black swan that I don’t think is likely to happen. Hopefully the market is wrong.


-RelPolEco

I am not sure how frequently I will be writing but please feel free to follow me. My hope (which my father always cautions is never a good investment strategy) is that whenever I am able to add articles, they will be of value for readers. Also don’t worry too much if you couldn’t follow the technical analysis, in my opinion it is nearly as worthless as these options.

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DISCLAIMER: Long AAPL. Short AAPL (covered) calls. Short AAPL puts. This article expresses only the views of the author. The strategy discussed involves selling uncovered put options which pose a significant risk. If you choose to follow this strategy I am not responsible for any errors, omissions, or actions taken as a result of reading this article. As a reminder, users of this site agree to be bound by our Terms of Use (the "TOU"). The site is not intended to provide tax, legal, insurance or investment advice, and nothing on the Site should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by Seeking Alpha or any third party. You alone are solely responsible for determining whether any investment, security or strategy, or any other product or service, is appropriate or suitable for you based on your investment objectives and personal and financial situation.


Disclosure: Disclosure: Long AAPL, Short AAPL (covered) calls, Short AAPL puts.