An Interesting Bet on Apple

Today I would like to share an actual spread I placed in my personal account today.  It is a simple bet that come January 18, 2013, Apple will be trading at some price above $500.  As I write this, AAPL is at $513.

This little bet will make 62% after commissions at any ending price above $500.  It doesn’t have to go up a penny to make this much in a single month.  In fact, it can fall $13 and the same gain will come my way.
Check it out.

An Interesting Bet on Apple

One of the biggest stock market mysteries I have ever experienced in 30 years of trading almost every day has been the recent implosion of Apple stock.  For years, I was on the lookout for companies whose P/E ratio was less than its growth rate.

Two months ago when AAPL was trading north of $700, its growth rate was more than double the P/E ratio (not even adjusting for cash), even taking the traditionally-conservative company projections for next quarter.  Opportunities like this are quite rare in the investment world, at least they have been in the past.

Since that time the stock has fallen nearly $200.  I was not alone in my surprise at such a drop.  The average price target for 48 analysts is $750.  How can so many presumably smart (and well-informed) people be so horribly wrong?  Maybe they aren’t, at least in the longer run.

Trying to catch the bottom of a falling stock has been compared to catching a knife dropped from a great height (with your bare hands, of course).  I must admit that I have made several attempts to catch a bottom over the past two months, and my portfolio value has dropped right along with the stock.  It has been a painful time for us Apple bulls.

But now I think the bottom is finally here.  From a technical standpoint, there seems to be a strong resistance point at $505.  I’m not much of a technical indicator guy, but so many people are that sometimes you just have to follow their lead.  It has come close to $505 a couple of weeks ago, rose sharply, and then retreated to test that level once again last week, and has since recovered a bit.

Much of the recent sell-off has been attributed to tax-related selling.  If a person had a huge gain in the stock (and anyone who has bought it in earlier years surely has), it might be better to sell your shares in 2012 to avoid what looks like a higher long-term capital gains rate that may be instituted in 2013.  Many people are expected the rate to increase from 15% to at least 25% next year.  That would make it a good time to take some profits.

Anyone who sold AAPL for tax reasons probably still likes the stock (after all, it did give them a big win) and may buy it back once they read about millions of new iPhone 5 sales at Christmas and in China (and now, even at Wal-Mart) and anticipate what those sales might mean to earnings.

There are many other reasons that the stock should be trading higher in 2013.  It usually spikes higher in advance of the January earnings announcement which should come just after the January options expire.  When the announcement is made, the P/E ratio will surely be even lower than it is today since this will be the first quarter when the iPhone 5 results are in (the most profitable Apple product, and the biggest problem has been making it fast enough to keep up with the demand).

So here’s the little bet I made that Apple will be trading at some point higher than $500 on January 18, 2013:

I bought AAPL Jan-13 495 puts and sold Jan-13 500 puts, collecting $195 per spread, or $192 after commissions (in options lingo, I sold a vertical put spread).  If the stock closes at any price below $495, I will have to buy the spread back for $500 and I will lose $308 (the maximum risk I am taking).

My broker will issue a maintenance requirement for $500 per spread (this is not a loan like a margin requirement, but $500 per spread will have to be set aside in the account).  Since I collected $192, my actual net charge will be $308.  By the way, this kind of a spread is allowed in IRA accounts at most brokerages, including thinkorswim.

At any price above $500, both options will expire worthless, no commissions will be due, and I will make a gain of $192 on my maximum risk of $308.  That works out to about 62% on my money at risk.  Not bad for one month.

Of course, you should not take this risk with money you can’t afford to lose.