Investors have had quite a ride in Apple (AAPL) since September of last year, at which time the stock began its massive decline from $703 to bottom out in the $385 area in April of this year. Apple later retested this area in late June, forming a double bottom pattern before rallying to this year’s highs. Apple appears to have completed the transition from a growth play to a value play. In prior years, Apple was sought after due to its continued innovation. Once the firm began maturing and new product innovation slowed, traders switched their bias and the stock became a value play.
Apple continues to look good fundamentally. The stock is trading at 14 times earnings. With a dividend of $12.20, at current levels, Apple has a yield of 2.20%, above its industry average. The company had no debt from 2009-2012 and even at its current leverage, the firm still has a debt/capital ratio of 12% which is well below the industry average. The firm’s quick ratio is also below the average of the industry indicating that the company will have no issue servicing its debt. Apple’s ROE and ROA 31% and 19% respectively, are both above the industry average. Net and Operating Margin also exceed that of its industry.
While Apple looks good fundamentally and as a long-term investment, the stock is just 3.5% off of its 52 week high. Apple, while leading the industry in revenue growth over the trailing twelve months, lagged the industry in revenue growth in its most recent quarter. EPS growth in the most recent quarter and trailing twelve months have also declined.
With the Fed likely to Taper within the coming months, this could present a key opportunity to scale into or add to an existing Apple position. I expect the Fed to Taper in December. However, March is the latest that most traders and economist expect Tapering to begin. Tapering, while beneficial to the broad economy, will result in a pullback in the equity market as traders price in the effect of less financial stimulus. After a significant correction, investors should begin to buy up stocks trading at advantageous multiples. I feel that Apple should be one these stocks.
I would look to begin scaling into Apple around the $495 area. Applying Elliot Wave Theory, Apple is currently ending the 3rd Wave. The stock experienced a Fibonacci retracement of 50% in the 2nd Wave which is not minor, but also not a typical retracement in the 2nd Wave. Applying the rule of alteration, I would expect Apple to pullback in the 4th Wave to somewhere within the $495-$510 area. This should be a good spot to begin scaling into a position.
AAPL Daily Chart
(click to enlarge chart)
Based on the projected retracement, we can draw channel lines to determine the impending chart pattern set-up. Based on the chart below, it appears that Apple could form a rising wedge in the coming months which would indicate that the stock could fall below the $495 area to bottom out possibly near the $450 area. To confirm this pattern, the 5th Wave to the upside would have to fail to exceed the top of the 3rd Wave. If the stock trades to the 38.2% Fib. retracement area in the 4th Wave and holds, I would reconsider my original target and begin scaling into a position at the $520 area with a profit target in the 5th Wave of $610.
AAPL Possible Rising Wedge Projection
If Apple does trade above the 3rd Wave, the chart pattern developed could be that of a flag which will signal a continuation higher. We can use Fibonacci tools to project our price target.
AAPL Possible Flag Projection
Taking the fundamental data and technical analysis into consideration, as well as the likelihood that the Fed will Taper in the coming months, I feel that Apple should sell off to the at least to the $510 area and later extend higher. One could play this trade in the options market by collaring a current position (collar=long put and short call) to hedge the short-term downside risk. The long put, out of the money, should be bought around the $540 area. I would then sell a call against it at the $595 area. Another strategy that one could use once the 4th Wave down was complete, to preserve capital, is to put on a synthetic long position, or sell a put and buy a call at the same strike price. With implied volatility exceeding historically volatility, options premiums will be higher on the Feb595Call which would generate a credit of about $12 Price would have to exceed the $595 level by Feb. expiry for you to lose your credit which I feel is unlikely. The market is pricing in a pullback which is why implied volatility on puts exceed that of historically volatility, thus elevating premiums. On the Collar’s long put at the $540 area, for Feb. expiry it cost about $22 for a net debit of $10 for the trade. If the stock falls to $510, the trade would profit $325 for a 3:1 risk/reward. If the stock falls to $495 by Feb expiry, you would have a $443 profit and a 4:1 risk/reward ratio.
As a risk management precaution, if the Apple breaks the 3rd wave high of $573, trading up from current levels, I would close the trade at a loss of about $125 and reassess the environment.