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Apple (AAPL): An Opportunity to Try Something Different

By: OptionsANIMAL
Posted: 1/25/2013 11:20:00 AM
Referenced Stocks: AAPL;GLD;IBM

Two days ago, Apple (AAPL) announced Q4 earnings for 2012 that represented the largest quarterly profit for a non-oil company in the history of mankind. Sales were so strong that the company couldn't produce enough devices to meet demand. They had produced a smaller, cheaper tablet that took market share while, unlike any competitor's device, was profitable. Of course, with all this good news, the stock collapsed. Ah, expectations are wonderful things! I understand that the company, for whatever reason, missed expectations. Generally those expectations are priced into a stock before the announcement and any reaction can therefore be justified. In Apple's case, however, the stock had lost around 30% in the previous four months. That isn't exactly pricing in overly optimistic forecasts.

All of this would make sense if AAPL were trading at massively inflated multiples based on predicted growth. When a growing company's stock is trading at 40 or 50 times trailing earnings any slowdown in the rate of growth can, and should, affect the price. AAPL however was trading at 12.2 times the previous four quarter's earnings before the Q4 release and is currently at around a 10.4 multiple of the last four releases including Tuesday's. For comparison IBM (IBM), whose aggressive growth days are presumably over, has a trailing P/E of around 14.75, calculated on the same basis. It should be noted that in both cases I am talking about trailing P/E, a number based on historical fact, not analysts' guesses for the future.

I understand that AAPL's best days could now be in the past, although I doubt it. Even if they are, however, the current valuation seems to be little influenced by reality. Just as analysts were falling over themselves to issue ever more ludicrous price targets over $1000 in July and August last year, so they are now beginning to compete for the most drastic downward revision. It seems that AAPL elicits emotional responses more than any other stock (with the possible exception of GLD) and we all know that emotion and trading go together like pickles and whipped cream.

Remember the words of the "Oracle of Omaha." Be greedy when others are fearful. On that basis, this could be a time for something that can rarely be recommended, buying out of the money naked calls. It can rarely be recommended because time decay will generally kill you. Out of the money calls only have time value, and the one certainty we have is that time will continue to pass. Buying something that is programmed to decrease in value every day is not usually a sound strategy. In this case, however, where you are looking for a massive swing in sentiment, the huge profit potential and limited potential losses are quite appealing.

This is not a play for the risk averse and certain things should be born in mind. Look for options with large open interest as you may need the liquidity to cut your position in the future, and bear in mind that you are simply looking for a rally to increase the value of your holding in the short term, not for the option to expire in the money.

The collapse of AAPL stock has been spectacular and unusual. It may be time for an unusual trade to take advantage of it.