On Thursday, November 1, Apple Inc. (AAPL) will be reporting Q3 earnings for 2018. This company and its stock is one of many Wall Street darlings, but this one seems to be able to stand apart for everyone else. This Friday on Options Action, Chart Master Carter Braxton Worth, performed a visual analysis of the stock’s price action and believes its bullish trend is likely to continue.
If you examine the share price action going back to the last election, you will see that the stock has been in a disciplined trend channel. Carter notes that it has bounced off the lower trend line 5 times and has been repelled by the upper trend line at least 3 times.
With an earning announcement looming, the 2 big questions investors have are (1) What is the earnings report going to look like (e.g. sales, profitability, guidance)? & How will investors react to that news? (2) Given that backdrop and the trade negotiation underway with China, how will the share price perform in the months ahead?
Carter’s analysis suggests that the share price is more likely to go higher than lower next week and the months following. This implies that investors will take a shine to the earnings report and feel comfortable with guidance. On an intermediate-term basis, Mike is expecting the company will announce some product upgrades on the iPad and iMac line of products. These product upgrade could be a catalyst to lift the share price as well.
Technically speaking, on a short-term basis, Carter notes that there is a little wedge forming. This coiling price action suggests the share price will make a sizable move anytime now. Given the upward bias, Carter believes the resolution of that wedge is likely to be at higher prices.
We consider the valuation picture to be in the neutral camp. EV/EBITDA is about 14, which is a little high for our tastes. A cash flow valuation of this level is consistent with a company that is growing faster than GDP. We think the company’s revenue growth rate going forward is about 5 to 7%, somewhat less than nominal GDP. However, the company buys back about 5% of its shares every year and this contributes to growth on a per share basis. So one can justify the enterprise value to revenue multiple, so long as the trend remains in place.
The company sports a PE ratio of about 20 and analysts expect earnings to grow by 20% or so, over the next year. At this point in time, Yahoo! reports that the average analyst expects the company to report EPS of $2.78 on Thursday. This would be up very sharply (close to 34%) from the same quarter last year. So it is a stretch number. Another area we are a bit nervous about is guidance. We are wondering what the effect of the trade tariffs might be on Apple products. So far, we hear that the company is not affected by them. So there is some potential for negative surprise. Apple products are already the most expensive in the market. Raising prices to offset the tariff could hurt unit sales and sucking up the tariff would certainly hurt margins.
Interestingly, AAPL is outperforming the market big time. Furthermore, the price of APPL has been holding up far better than the S&P500 during this recent selloff. Those that have read our macro market comments earlier in the week would know that we think a bounce could be ahead for the broad market at any time. Could APPL be the catalyst for that? Or maybe AAPL will be the beneficiary of it.
Put this all together and Mike constructed a bullish trade which he shared on Friday’s show. He suggested buying a Call Spread Risk Reversal (CSRR). A CSRR is constructed by purchasing a call spread and selling a call to help pay for it.
The following analysis updates this trade using the Friday’s closing prices. Apple finished the days trading at $216.30.
By purchasing the center and selling the wings, the cost of the structure falls to a manageable level. With a $20 spread between the call strikes, there is plenty of upside potential as well. However, the investor must be aware that if the share price falls below $195, the stock could be put to them and they would become the proud owner of AAPL stock a $197.62 ($195 strike and $2.62 premia). The good news is that this is about $20 below the current price, so there is room for error. This structure is somewhat out of the money so the probability of success is just 39%.
But what if you wanted to make a bullish play with a higher probability of success. One could sell a slightly out of the money put spread. Using the same expiration and strikes shown in the exhibit below, one would generate $385 up front which they keep so long as the share price trades above $215 at expiration. This trade has a 55% chance of success, but a much smaller potential for profit.
But what if you just wanted to take a leap on earnings. One could simply buy a call that expires next Friday. A $217.5 strike call would cost $5.70, so the share price would have to rise to over $223.20 sometime during the week to turn a profit. There is a 31% chance of this happening. On the plus side, the most one can lose is the premium paid upfront. If the share price rises to $240 on a blow out move, one would make about the same as the CSRR would deliver.
Naturally, if you think Carter is off base (we mentioned a number of fundamental reasons above why you might want to think so) and that the bear market is about to eat the AAPL, one might want to sell the CSRR or buy a put spread or sell a call spread. To make a pure earnings bet, instead of buying a call, one would buy a put. If you used a $215 strike, expect to pay $5.90.
We like to remind our readers that investing involves risk and that it is possible for one to lose most or all their investment when trading options (or any investment for that matter). Be sure to trade within the limits of your capital. Limit the size of your trades to an amount that will not harm you should they result in a loss.
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