Friday, September 14, 2012

AAPL: Keep the rabbits coming

This is roll 'em over day for my diagonal spreads and covered calls, the day when I close out the September call options I sold in preparation for new sales of October options.

(Read a description of my diagonal spread and covered call strategy here.)

Roll 'em over day also provides a chance to switch strategies.

Apple Inc. (AAPL) is a case in point.

I've been selling calls against AAPL in a diagonal spread strategy. A Turtle Trading signal on Thursday has given me motivation to switch to a straight bull play.

Turtle Trading is the other side of my strategy mix. Where diagonal spreads and covered calls have a limited profit no matter how high the stock rises, directional trades under the Turtle strategy have unlimited potential for profit.

(See a discussion of the Turtle Trading rules here.)

As the world knows, AAPL has been on a big rise since early 2009, when it hit a swing low of $78.20. It's most recent leg up began in mid-May from $522.18.

No rise is uninterrupted, of course, and the Turtle Trading rules provide scope for opening a position in a stock that is in the midst of a long-term trend. It would have been nice had I loaded up on AAPL in January 2009. But I didn't, so what do I do today?

The Turtle rules say that a bull position is closed when the price breaks the 10-day low, as AAPL did on Tuesday, when it broke below $657.25.

The stock then rose, sharply, breaking through the 55-day high of $683.29 on Thursday and then pushing ahead today to a high of $695.86.

By the Turtle rules, Thursday's breakout was a buying signal, and so I have closed the short half of my AAPL diagonal spread, but I retain a bullish position in AAPL in the form of a long spread.

The point I'm making is that although I'm running multiple strategies, a position can easily be morphed from one into the other. If AAPL should again fall below it's 10-day low, I can salvage some profit by selling calls against the long calls I own, flipping the AAPL play back to a diagonal spread.

By traditional analysis, AAPL has been in blue-sky territory since 2009. There is no upside resistance. So for the trader, it's merely a question of picking a reasonable entry point. The Turtle bull signal provides that reasonable entry point.

By the numbers:

Analysts love AAPL. I mean, swooning, head-over-heels love, with an enthusiasm index of 85%.

Which is understandable, with a return on equity of 42% and no long-term debt.

With annual earnings per share that more than doubled from 2009 to 2010, and then nearly doubled again in 2011.

With estimates for 2012 running at nearly 60% above 2011.

What's not to like is the pattern of the quarterly earnings in 2012. They peaked mightily in the 1st quarter, and then fell sharply in Q2 and again in Q3. The 3rd quarter was one of two downside earnings surprises in the past dozen quarters.

Apple's business model, like those of all computer hardware makers, depends upon coming up with cool products that inspire customers to abandon what they own and to dig deep to buy the new stuff.

Apple's problem is this: It has to keep pulling rabbits out of the hat, each fluffier and cuter than the one before. At some point, presumably, Apple will run out of rabbits. What that will do to the stock price is terrifying to contemplate, given the fact that for many investors, AAPL has been the magic profit engine of their portfolios.

Institutions own 64% of AAPL shares, and the stock is expensive -- it takes $4.30 in shares to control a dollar in sales.

So, Memo to Apple: Keep the rabbits coming.

AAPL on average trades 16.6 million shares a day and has one of the broadest and most complete option strike price grids of any stock.Open interest routinely stands in the four- and five-figures, and the front-month at-the-money bid/ask spread is a ridiculous 0.67%.

Implied volatility stands at 25%, in the lower half of the six-month range. It has fallen sharply this week after a sideways period in early September.

Options are pricing in confidence that 68.2% of trades will fall  between $645.24 and $745.66 in the next month, for a potential gain or loss of 7%.

Options are trading very actively, at 269% of the five-day average volume. Calls and puts are equally active, at 268% and 269%, respectively.

Today's fair-price zone, 4-1/2 hours before the close, runs from $685 to $693.81, encompassing 68.2% of trades surrounding the most-traded price, $687.01. The stock is trading above the fair-price zone.

Apple, whose new iPhone 5 starts shipping on Sept. 21, next publishes earnings on Oct. 15. The stock goes ex-dividend in November for a quarterly payout yielding 1.53% annualized.

Decision for my account: As noted above, I'm long AAPL under Turtle Trading rules. The position is structured as long calls with a strike of $640, expiring in December, with 7x leverage.

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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