Chapter 1: The Preamble to the Apple 10-Bagger

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Chapter 1: The Preamble to the Apple 10-bagger
Chapter 2: The General Investment Thesis
Chapter 3: Analyzing the Risk

Thursday, August 18, 2011 -- As the market continues its second leg down, I think it's time for Bullish Cross to refocus its efforts back to covering Apple. So much has taken place since Apple reported its fiscal third quarter results, and we now need to review a lot of that material.

Moreover, given the amount of strength we saw in Apple on this August crash, it is absolutely clear that the thesis underlying the January 2013 call-spreads have been significantly bolstered. If you had any concerns that Apple might not make it to $500 - $600 a share by 2013, those reservations should be completely gone in light of the strength we saw during the first leg down, and on today's sell-off as well (August 18).

The S&P 500 lost nearly 250-points -- 18.5% in less than 15-trading session in early August. During that same period of time, Apple lost a mere 12.9%. In the financial crisis, Apple far underperformed the S&P 500 in basically the same sell-off. While the S&P lost 30% during the peak of the crisis in September 2008, Apple lost 60% of its value in the same period.

What this should tell you is that we're dealing with a new and improved Apple. We now have an Apple that doesn't fall uncontrollably due to a general lack of understanding by the institutions holding the company. Instead of selling Apple as a source of cash-liquidity in crisis mode, institutions are looking for other things to sell. That has never been the case as long as I've analyzed Apple.

Apple has always been the first to skyrocket on a recovery, and the first to be thrown off of a cliff in a sell-off. In the past, we've seen 20% sell-offs in the S&P 500 lead to 50% sell-offs in Apple.

Because we didn't see that in this August crash, I'm upgrading my assessment on all Apple spreads heading into 2013. Many people who read the early investment report that I put together back in June will remember that the underlying risk I raised with respect to the $400 - $500 call-spread was that the stock could potentially trade at $400 a share come October 2012. I argued that if we happened to see some sort of a second financial crisis, that with $40.00 in earnings, the stock could trade at a 10 P/E ratio or $400 a share.

We argued that this would likely price the $400 - $500 spread at around $20.00 a share which is the cost-basis that we've been advocating as being the most optimal given the risk-reward profile. I think given the strength we saw in this August correction, that we have to upgrade our risk-assessment to an 11 P/E ratio.

I don't think we will see Apple trade under an 11 P/E come the fall of 2012 even if we saw some sort of a financial crisis. It seems that Apple has finally been able to detach itself from the insanity of the broader market.

Thus, at an 11 P/E ratio on about $40.00 in earnings, this means that Apple probably won't be trading under $440.00 come October 2012 even under very strenuous circumstances. Right now, the January 2013 $400 - $500 call-spread costs about $30.00 a share. Thus, I believe an investor purchasing those call-spreads today will not only probably make a 234% profit, but he or she will be able to produce those gains with very little risk of loss if held through the year. While there could be a drawdown between now and January 2013, that spread is rock solid.

The day before Apple bottomed in June, Bullish Cross initiated its fourth ever public buy-rating on Apple. Historically, every single time we've done this, the stock has bottomed within days and a few percentage points of making the call. As we explain in the article, we've hit every one of our price targets far ahead of time.

Following our own buy rating, we took our full position in the January 2013 $400 - $500 call-spread when Apple was sitting under $320.00 a share. We paid a mere $17.20 for those contracts. Now we just merely have to hold that spread until expiration to collect on our 482% gain or $4.82 million. You can see our full position here, and the June Investment Report which was the basis of our position here.

Anyone who followed the Bullish Cross model on this spread is not only up tremendously, but he or she is now also very well positioned to make a significant amount of money. At the time, I really wanted to just come out and say that this spread was something that you could feel comfortable betting the farm on. If someone gave me $1 million back in June, I would have went all-in on that position.

And the reason for this is simply because you couldn't reasonably argue against any of the analysis. The chance that Apple will trade at a 10 P/E ratio come October 2012 is extremely low and if that happened to be the case, I would be up $300,000.00 anyways. So the reasonable worst case scenario puts me up $300,000 but the very reasonable and likely best case scenario puts me up $4 million? I don't think there was another time in my entire life where I felt so frustrated by the fact that I didn't have access to $1 million.

Also, I knew at the time that the pricing was actually unreasonable and unsustainable. That even when Apple was sitting at $310 - $320 a share, that spread should have been trading at $25 - $30. When Apple got as low as $310, that spread cost $14.00. I know because I bought a significant amount at that level for my uncle -- nearly 20% of his entire portfolio. He's up 100% even in light of this sell-off.

Thus, I can't impress upon everyone how extremely important it is not to mess with that position. You're not going to find any intermediate-term or short-term opportunity that will have a better risk-reward profile than that spread. Think of it this way. If you sell your position here, how certain are you that you will be able to make at least 240% from this current level? Are you going to be able to make up the difference you get with long-term capital gains recognition in the 2013 spread?

One of the biggest reasons that this spread is irreplaceable is because not only are you going to make 400-500% from where you entered, you're going to get long-term tax treatment. Please see the difference between long-term and short-term capital gains -- we're talking the difference between 15% and 35% tax treatment.

But we'll get back to discussing the topic of what to do with the 2013 $400 - $500 call-spread in light of this new opportunity that Bullish Cross will be discussing over the next few days. Another reason why the JAN 2013 Call-Spread is such a great investment is because I think the market is going to start taking Apple's valuation very seriously next year.

I believe the days of Apple being treated as the bastard child of Wall Street when it comes to valuation will no longer be the case in 2012 - 2013. Apple is sitting at the horizon of a massive breakout that will push the stock well into the $500 a share sometime in the middle of next-year. $500 will happen far sooner than anyone thinks despite the recent sell-off on Wall Street.

We will probably see some further selling pressure over the next week or so on this second leg down in the markets. That pull-back will represent the very last opportunity to buy the stock before everyone tramples over each other to buy every share they can get their hands on. Depending on how things play out here, you don't want to head into September without taking your Apple position.

This chapter is merely a preamble to a multi-chapter piece in a much larger Apple analysis that I'll be running through over the next few days and weeks. And as the title of this article indicates, we're also going to start a new higher-risk portfolio this week with a target gain of 1,000% on the year.

We're going to use multiple Apple strategies to build some significant gains through multiple trades. I'm fairly confident that we will be able to nail this trade in its entirety. Here's what we're going to do. We're going to begin this portfolio with a trade in some Apple October 2011 call-spreads. This is a higher risk portfolio, and if you want to follow the strategy then you need to first figure out the amount of risk you want to take.

The next chapter will only be covering the general investment thesis.
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Go to Chapter 2: The General Investment Thesis>>>

14 responses to “Chapter 1: The Preamble to the Apple 10-Bagger

  1. Pingback: Chapter 1: Preamble to The Bullish Cross Apple 10-Bagger | Bullish Cross

  2. Great set up! Can’t wait.

  3. I think I understand the beginning of the thesis, the rationale and the viewpoint. My only question is the one that every risk averse investor asks when I discuss having large apple exposure – What about Steve Jobs’ health? Or to put it more bluntly, what happens if he dies? Apple is most assuredly firing on all cylinders. But the overhang that causes one of the best run and fastest growing companies in the world to trade at 13.36x this years earnings is their leader’s health. Do you have a view on this?

  4. Andy
    I may not sleep until I can execute on this thesis. BC has provided me with the insight to trade out of long positions early and to buy back in at lower values, followed by additional sales yesterday and some more today that I can clearly see will enable me to regain my positions at even lower values. I no longer feel I am guessing and trading on gut instinct. It is refreshing to not panic on a huge down day
    I am excited to get back into Apple
    When you launch your fund. I will be there. Please accept funds from Canada

  5. The only thing that gives me pause on your thesis is whether a global slowdown might take a dent out of Apple’s growth rate, resulting in Apple missing your revenue and earnings forecast for the next year or two. I know all the positives – iPhone, iPad, MacBook Air, China and so on, but if people really pull back on spending, you’d think Apple would feel it, at least a little bit. If $40 EPS becomes $36, at 11x…. you get the picture.

    • Never going to happen. That’s what people thought in 2008. Nothing even happened. In fact, believe it or not, Apple’s best quarter over the past 5-years came in fiscal Q1 2009. Do you know when that is?

      October, November, December 2008. In the middle of the crisis, Apple’s earnings rose 150%. Don’t get too caught up in the global recession story. It won’t dent Apple’s EPS by $4.00. If Anything, it would hit Apple’s bottom line to the tune of $0.12 at most.

      • Andy – I remember q1 2009 well because I had the same concerns AJ mentioned. I agree that Apple came through really well but just checking on your numbers. Looks like net income was up about 45% going off the old “adjusted net income” language 2.3 B vs 1.58 B. Am I missing something?

        But as you said, morale of the story – growth continued.

  6. Any explanation on why TD shows the 2013 JAN calls to be on 19th and not 18th?

  7. I am uncertain how the Jan 13 BCS scenario is entirely subject to a 15% tax basis. Anytime you write a call us it not an automatic short-term gain? The bought call (if held for a year) would be considered a long-term gain so your overall basis wouldn’t be 35% but somewhere in between 15 to 35%. What am I missing?

  8. is there any advice on the site on how to deal with our otion trades as they get closer to expiration specifically the october spead,,ie what should we expect with respect to pricing as we get closer to expiration,,ie when will the full value of the spread be realized ?

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