No doubt, you’ve seen the news lately that Apple has fallen from the world’s largest company by market capitalization to the number two spot behind rival Microsoft. As we write, the two are tied, dead even at $850 billion in market cap.
The reason for this new arrangement is the heavy losses Apple suffered following the weak sales of its latest iPhones. The September launch of the iPhone XS and last month’s launch of the iPhone XR were more or less busts.
The company’s price points, according to many gadget geeks, were simply too high. The “XS” sells for $999, while the “cheaper XR” version sells for $749. That’s a hard sell for even the most die-hard Apple enthusiasts, many of whom just a year earlier bought the $999 iPhone X.
This has forced the company to cut production of the new phones from their first estimates, heading into the shopping season.
At least, that’s the story every newspaper and financial blog has been running with over the last month. Most of this is true. However, units sold and revenues are two different things.
First of all, the iPhone XR has not been a failure as is often reported. It is currently Apple’s best-selling product. And it has only been on the market for one month, entering a time when many splurge on just such a device.
Secondly, those high price points more than make up for a slight dip in unit sales. Analysts are still expecting the company to report revenues of $92 billion for the fourth quarter. That’s 4.1% higher than last year’s numbers. And since these two launches came during two different quarters, it’s harder to judge their success by looking at just one quarter.
But that hasn’t stopped many investors from taking their cash out for the time being:
All of this is almost beside the point, however. Apple is going to be just fine. It is still recognized as the best brand in the world, with some of the most loyal customers. And there’s good reason to believe that this latest bout of stock selling is going to end…
The Strongest Indicator is Flashing Buy
One of the most important indicators for companies like Apple is consumer sentiment. When people feel good about the economy and their own personal finances, they are much more likely to go out and buy a $999 phone for themselves.
So, when looking at recent consumer sentiment numbers, you might be confused as to why Apple shares have been selling:
The above chart shows the past 10 years of the University of Michigan Consumer Sentiment Index. This is one of the best gauges to measure overall feelings about the economy… and how likely consumers are to spend for items like an iPhone.
As you can see, the sentiment in the US is quite high… the highest it’s been for more than a decade, as a matter of fact.
With consumer sentiment this high entering the holiday shopping season, Apple should be sitting pretty. And they likely are.
The company can almost underperform and still surprise investors and analysts on the upside. With the negative press about the most recent launches, any boost in sales figures or earnings could send shares back up. And with these factors coming together – seasonal shopping and high consumer sentiment – in relation to two new products on the market for Apple, the timing for such a pleasant surprise is right.
Finally, let’s not forget just how far Apple has fallen. True, it still is up on the year at about 6.2% higher than this time last year. But before these launches, Apple was up 37% from last December.
In more practical terms, that means investors are discounting Apple’s earnings potential or are simply selling because of headlines. To a more neutral observer, the latter is far more likely. Just take a look at its numbers.
The company’s $180 stock price is just 14.9 times its last 12 months of earnings per share. That’s below market average. When looking at future earnings, this discount is even larger. Based on analysts’ estimations, the company is trading at just 12.2 times its forward earnings. Compare that to Microsoft’s trailing P/E of 26.5 and forward P/E of 22.1. It’s clear Apple has room to recover.
All of this makes it seem like there’s a good chance Apple shares will have an excellent December. But we can’t guarantee that the negative press will stop. So, how do you play something like that?
Fortunately, there’s a trading strategy for just such a scenario.
A Trade for Short-Term Bulls
Apple’s shares are some of the highest-held ones in the world. After all, it’s tied as the largest company in the world right now. But even though it looks like those shares could rise to where they were trading at this summer, that doesn’t mean they aren’t at risk of falling. With a price tag of $180 per share, they are still an expensive way to invest.
Alternatively, a bullish investor could simply buy call options on Apple to get the same and even higher returns if shares do rise. But that proposition is even riskier, since in the event of shares falling further in the short term, those calls would expire worthless — in other words, a 100% loss on the investment.
So, for short-term bulls a bull call spread strategy offers a great middle ground. The way it works is by buying a call, but offsetting that price by selling another call with a higher strike price.
Here’s a graph of how this kind of trade works:
Source: The Options Industry Council
A trader who makes a bull call spread trade sees a profit on rising share prices. His risk is limited to the difference in premiums of the call options. So, the total amount at risk is found by taking the amount paid for the call option the trader bought and subtracting the amount he received from the call option he sold.
That’s the total risk in this trade.
The maximum profit is found by taking the difference in strike prices between the options and subtracting the amount of capital it took to enter the trade. Let’s look at a specific example in this scenario.
A Specific Apple Bull Call Spread Trade
A bullish trader could buy a December 21 $180 call for $5.75 per share and sell a December 21 $182.50 call for $4.50 per share for a total net debit of $1.25 per share. Since each contract represents 100 shares, that’s a total cost of $125 to enter this trade. That’s cheaper than buying a single share of Apple.
That $125 is the total amount the trader would have at risk for the full duration of this trade, which expires in three weeks.
The maximum profit potential for this trade is found by taking the difference in strike prices ($182.50 – $180 = $2.50) and subtracting the cost to enter the trade ($2.50 – $1.25 = $1.25), then multiplying by 100 shares ($1.25 x 100 shares = $125).
So, the risk is the same as the reward. Meaning this trade comes with a 100% return potential on the amount of money at risk.
Clearly, a 100% return by simply buying shares is extremely unlikely. And since this trade offsets some of the cost of simply buying a call outright, the amount risked is lower.
To reach this 100% return on risk, shares of Apple would have to reach $182.50 (the higher of the two strike prices) by December 21 (the expiration date of the calls). That is an extremely possible move for AAPL shares. That’s just a 1.4% price movement for a potential 100% return.
— The Option Specialist