I'm going to try to make this as straight-forward as possible. Sometimes if I'm under a time constraint, just try to take me at my word instead of me having to present a lot of material. The conclusions are still going to be the same.
Here's what I think you can take from today's miss in terms of how to play it if you're invested in Apple. Obviously, what you're holding and at which expiration matters tremendously. And we will get to that.
But here's what you should take from today's sell-off. Today's sell-off puts in a top for Apple. The end of October and beginning November is always marked by a sell-off in Apple's stock price. That's why we run this whole analysis that indicates that Apple is typically down 4-weeks after earnings. Those who don't play earnings at all will be able to buy the stock back at a significant discount 4-weeks later.
I think the beginning of that sell-off started today rather than tomorrow at the open of trading. Usually, what we would see is a gap-up, high and then sell-off. We just missed the process by 1 trading session. Apple hit a new all-time high of $426.70 and that will mark the point of resistance at some distant future point in time -- like maybe 4-5 weeks from now.
So we might get something like 5-10 trading sessions of straight down like we've seen in the past. Remember last time Apple was at $420 a share? The stock sold-off $70.00 in just 10 trading sessions or something like that. I doubt we will see the same this time around, but I think that's the general idea here. We're probably going to see some selling pressure. That's especially the case if the market sentiment shifts against Apple.
We will get into the market sentiment issue over the next few days. Basically, here's the problem. The market sentiment is just as important as the financial reality. The market perception -- however flawed -- is even more important than the reality so long as that perception is dominant.
For example, if the market believes that Apple's growth is slowing due to the global macroeconomic environment, then that might as well be the reality for the short and intermediate term at least.
During the financial crisis Apple was more punished than most other stocks. It was punished almost to the same degree as financial stocks. It most undervalued large-cap tech stock.
That was the case because the market perception at the time was that the iPod = Apple and iPod sales are slowing due to the crisis. Well neither point was true. First of all, Apple's dependence on the iPod was gone by 2008. Apple's revenue was dominated by the Mac and the iPhone. On top of that, iPod sales were still growing dramatically at the time.
I tried to defend Apple on this point, and Apple investors thought I was actually attacking Apple! I was attacking the perception that the iPod = Apple and Apple = iPod in order to try and shift public opinion about whether the iPod matters anymore and I got like 170 comments of negativity. Fun times. I remember publishing this chart back in the day:
But I think the 2008-issue was a good example of how sentiment really impacted the stock price. Apple got beaten up more than a lot of its peers. The stock lost 62% of its value between 2007 and 2009.
If you sentiment at the time, it didn't comport with the actual reality. Apple reported its best earnings number on record in fiscal Q4 2008 posting 150% income growth on the quarter. That quarter still sticks out like a sore thumb.
Well we may be in the process of seeing this happen again. Not to the same degree as 2008, but I would say to the same degree as we saw during certain parts of 2010 and the first half of 2011.
The perception of the market could be as follows. Or it can develop as follows over the next few days. We're going to have to wait and see. People are going to view this miss as a clear indication that Apple = Steve Jobs and Steve Jobs = Apple. They're going to attribute this miss on earnings to a slowdown in the global macroeconomic environment and all the bubble-idiots are going to come out and say Apple = Largest Market Cap Stock = Bubble Stock = Finally it should pop.
Then you're going to get the people who think this is a slowdown in Apple's growth. Not necessarily the global growth, but that Apple's growth has finally stalled. Apple missed = the analysts are always right = Apple's growth stalled. The real growth numbers don't actually matter. It's the perception.
And as long as this perception that Apple is slowing down because it missed and Apple cannot function without Steve Jobs because it missed continues, then the stock will be pretty weak unless (1) Steve Jobs finds out how to arise; and (2) Apple can convince the market with reason that it is not slowing down.
Ok. So that is one distinct way that the perception -- however flawed -- can take hold over Apple. But another perception can develop in the markets and I'm trying to help perpetuate this. Like it's all really a battle of the perceptions. One will win out and one will eventually die and Apple will trade on the perception.
The market might view this quarter as a one-off event driven largely by a transitional period in the company to the iPhone 4S and that Apple's fiscal Q1 guidance proves that Q4's missing revenue will just be pushed over into fiscal Q1. That Apple's revenue next quarter will prove that this quarter was just a rare exception of analysts going too far with their estimates.
If this perception takes hold -- which I've also seen happen in a bearish situation like today -- then Apple could very well set a low tomorrow, and rally out of it. It may not go back to the highs, but it could very well set the lows. Take a look at what happened in fiscal Q4 2010 for instances. We had a big sell-off on the quarter. Apple got as low as $300 after losing $19.00 on the results. That was a 6% move. But after setting that low, it moved higher.
At some point tomorrow, I believe Apple will test $400 a share. And while I know that some of you would be disappointed with that, just remember where we were 2-3 weeks ago. Remember where we were when Steve Jobs passed away. If you go back exactly 7-trading sessions ago, the stock was at $369.00 a share. And now I can feel it that people believe the world is ending when Apple can very well close at $400?
I mean the whole entire thesis was to see a close above $400 right? When we were at $355, the thesis I put forth was that Apple had a good chance to close above $400 at expiration and that we believed that it would at least close above $380 at expiration. So much happened in the last 7-trading sessions where now $400 seems so shitty all of a sudden? Funny how things work out. Apple misses and the stock might still close at $400 and a lot of investors would be unhappy about that. That's an issue of positioning.
Now lets take a look at the history to see how Apple did whenever it did have a gap-down open. This table below was published in the "Friday" analysis which I think is now very important in analyzing the downside. Table 2 is basically the same as Table 1, but it focuses on just the days where Apple gapped-down:
So here is what I think is going to happen and I could end up being wrong on this. It is a very unique situation because Apple did miss on earnings. Most of the time when the stock sells off, it's mostly because it was over-extended going into the result or because the market decided to sell it off on a stupid reason. This time, the stock missed. So it's expected to see a legitimate sell-off here.
That being said, I think Apple is going to open-up pretty much where it closed today, set a low of the day very early on like at 9:45 - 10:30 AM. Sometime in that period. I think the low of the day wont' be much lower than where the stock has opened and then I think the stock will rally all day.
I think we're just going to see an all around repeat of fiscal Q4 2010. In fiscal Q4 2010, Apple gapped down into the $303.40 area, set the close of the day at $300.02 and then rallied all the way up to $313.77. It almost went green on the day. Then we saw a second-half of the day sell-off down to the $309.49 area.
Interestingly enough, if you look at the chart above, Apple pretty much closed on Friday where it closed on earnings day. So for example, on the day after fiscal Q4 2010 earnings where were reported on a Monday, Apple closed at $309.49 that day. It then closed at $307.47 on Friday.
Then take a look at fiscal Q3 2008. I think that is the quarter which most closely resembles this quarter. We got some very bad fundamental news that quarter with the gross margin guidance fiasco. I don't think I was ever more upset with Apple's management than that quarter. People were just dumbfounded. Like why the hell would you give full-year guidance on gross margins when no one was expecting it?
Apple never gives full-year guidance and then out of thin air they give a full year gross margin number that doesn't even make sense. It would be like Apple today saying, next year we expect gross margin to be down to 32% on the year for no good reason, and then they report 41% for every quarter in 2012. Like what the hell?
But anyways. Here's what happened that quarter. I remember it like it was yesterday. I watched it all unfold in front of me. The stock gapped down very hard and opened deep in the red the day after earnings. It opened 10.58% lower as it dropped from $166.29 to $149.00 at the open. The stock sharply sold off right at the opening bell (expect that to happen tomorrow) as it lost about $2.50 from the open.
But then something very strange, pleasant and major happened. Which is huge when you're talking a 10.58% down day. The stock reversed course, was bought up all day long and slowly almost turned green on the day! It was literally a buy fest that lasted the entire trading session. I remember people going crazy on it.
The stock went from $146.53 in the very early morning all the way back up to $162.76 and then closed only $0.74 from the high at $162.02. In the end, it was a drop in the bucked. The stock opened down 10.58% and closed down only 2.57%. Then the stock closed that Friday at basically the same price that it closed the day after earnings. $162.12. That's $0.10 higher than the close on earnings day.
I think there's a very strong chance that we could see that tomorrow. I know this generally trend will probably take place tomorrow. But the strength of that trend could be big. We could see Apple close at like $410 - $415 tomorrow. Very easily that can happen.
But I think the more likely scenario is something like fiscal Q4. It's the same exact trading pattern. It's just the opposite of what you get with gap-up opens. Notice that with gap-up opens, Apple tends to sell-off all day long after putting in a top shortly after the open.
Well we've seen this type of trend happen in two out of the last four gap-downs. In the other two gap-downs -- January 2008 and January 2007 -- we had different results. In fiscal Q1 2008, Apple was in the middle of a melt-down with the broader market. Apple was reporting on a week where the market was straight-up collapsing. For those who were around in January 2008, you will remember that Apple went from $202.96 all the way down to $115.00 a share in less than 5 weeks time. That's almost a 50% loss for no Apple related reason at all.
That earnings day sucked. Apple gapped down lower, saw a massive low from that gap-down of -18.95% but then closed the session only down 10.65%. So in none of these three cases we talk about does Apple close lower than its opening price. That tells you to avoid selling at the open like the plague.
That is unless of course this is anything like fiscal Q1 2007. In that quarter, Apple closed about $2.00 (2.1%) below its opening price. Apple gapped down $2.85 from $94.95 -- a typical sell-the news earnings report. If you remember Q1 2007, that sell-off had less to do with Apple's earnings and more to do with the fact that Apple had risen too much. In fact, the earnings report was an absolute blowout. I remember the quarter well and I can even visualize where I was at the time.
The stock got halted that day because Apple reported a 50% blowout number. Analysts were expected $0.65 a share and Apple reported $1.14. I think it was something like that. I need to go back and look at my history. I'm pretty sure I'm right about both numbers though and I'm definitely right about the halt due to the blowout. Of course everyone on message boards thought Apple was about to skyrocket. Sadly they didn't really understand the idea that the stock had risen too fast.
But that was a quarter where we don't want to see that type of performance. Want to see here is something like a gap-down into the $394.00 area, a low down in the $388.70 area, followed by a sharp immediate rise back up to the open level and then a drift higher for a while until the stock gets to a high of $410.00 a share. Then I can imagine a close at around $400.00. I think we close Friday at $400 a share.
I can see that recovery mid-day being explained by analysts on CNBC as being attributed to the fact that the company did guide for $37 billion. WIth such a strong guidance number, investors are using the opportunity to buy on the dips. Here's a table of that type of outlook:
Now here's what I would do if I were you. Suppose you're holding the $400 - $410 October call-spread. If you see Apple rally sharply into that $400 - $410 range and you can get out at break even, then do so. There's no telling how far that rebound will go. There will be a bounce tomorrow that will give you an opportunity to exit that position. I'm going to try my best to guide everyone who might be holding higher strike position to sell.
Because here's what's going to happen. Apple will close the day off the lows. But it probably won't close at or near the highs. You should use this history as a guide. There's a reason we see the same type of trading action. I may even buy a position right at the open tomorrow to sell it on a rebound higher. Because that's a lot of volatility. We're talking a potential $20.00 range from $388 to $410 right?
Just don't get f'ing greedy if you are saved by a surge higher. Get the hell out dodge just in case. At this point, don't view this as an investment anymore. So do away with the greed aspect of the trade. If you can get out at even, get out.
If you're holding the $410 - $420 spread, then you're waiting for a miracle. With those people, there's always a chance that this could be Amazon all over again. In July 2010, Amazon reported a huge miss on earnings. The stock sold-off $25.00 in after-hours. It was trading at $95.00 down from $120.00 going into the close I believe. The next day it opened at $106.00. So that was $10.00 higher than where it was trading in after-hours. Then the stock pulled an Apple, except far more incredible. It went all the way back up to $120.00 on the day. Notice the gigantic hollow red bar on the chart. And naturally because the stock missed on earnings, it bottomed and then went on a massive rally.
So the $410 - $420 people are going to have to pray for Amazon Part 2. But don't bet on it. It's a very rare phenomenon to see that much interest come in on a miss. Only Bubble Amazon can pull something like that off.
Now we have the $390 - $400 call holders. You guys need to ditch the stock the minute it goes on a rally off the open. If you can get almost full value, just take it and call it a day. You're playing with massive fire tomorrow. So don't get greedy and get out with your skin.
The $380 - $400 spread holders who thought they lost it all when Apple was trading in the $355's had their hopes dashed last night. As with the $390 - $400 option holders, you need to GTFO of Dodge if you see Apple print above $400 tomorrow which I do expect will happen.
The $370 - $380 spread holders are borderline. With those spread holders, I would say it depends largely on how much you have on the table and how much those spreads are going for tomorrow. If the market expects you to pay up $2.00 or something to get out, I would give the finger to the market. That's just me. I think those are ok even with this sell-off. If Apple gets closer to $380, then you can start thinking about ditching out.
Anyone holding spreads that involve $360 - $370 or $360 - $380 are fine. I think what I will do tomorrow is this. I think I'm going to help bail everyone out. I will give some guidance on what to do and when. Like I might say, ok $370 -$380 spread holders, sell your shit.
The options I'm going to be thinking about are $410 - $420; $400 - $410; $390 - $400, $380 - $400; and $370 - $380. If you are holding something like the $420 - $430, I hope you learned your lesson. There's nothing you can do beside pray and hope. The delta on all of these options are going to skyrocket tomorrow.
If you're holding November unhedged options, then you're going to be screwed all around. Although I should say that Apple does have a tendency to test the highs in November. So you get a sell-off at the end of October and beginning of November followed by a re-test of those highs. So you should be aware of that if you're holding Novembers.
January spread holders are fine. Hopefully anyone who was long unhedged January calls, put on a spread today. 2013 naked call holders like Bullish Cross with the $450 calls at $41.05 a contract cost-basis are ok. We're ok on that for now and we will consider even selling some calls against that position finally if Apple rallies into the $410 area as expected. The reason we will now sell calls is because we expect to see some downward pressure on the stock after the week ends. I think there's a good chance that whatever high is printed tomorrow could be the high for a while. So stay tuned for tomorrow. Shit I'm exhausted.