Apple: Time to Do Away with Thermonuclear

Apple (AAPL) is currently at the center of a large number of mobile patent lawsuits. The company is not merely intent on licensing its technology as International Business Machines (IBM), Microsoft (MSFT) and others. No, Apple seeks to go “thermonuclear” as Steve Jobs has been quoted as saying with the hopes of fending off competitors in court rather in the market place. Albert Einstein is quoted as saying, “I know not with what weapons World War III will be fought, but World War IV will be fought with sticks and stones.” In light of Einstein’s quote, maybe Apple should reconsider its thermonuclear posture, especially, considering the company ranked 39th on the list of companies awarded patents in 2011. No surprise, on top of the patent pile for 2011 was once again IBM, followed by Samsung and Microsoft. Before a company goes thermonuclear, it should at least have the best quiver of arrows. Maybe Apple thinks it has the “biggest arrow” that trumps all others.

Apple’s ranting has apparently provoked one British judge to order the company to run advertisements saying that Samsung did not copy the iPad. Apple has been ordered to by the judge to place the advertisements on its website and in British newspapers for six months. The judge went so far to say Samsung’s product did not infringe Apple’s technology, as Samsung’s product was not “as cool.”

Apple has reason to be fearful, as Samsung appears to be widening its lead over Apple in smartphone sales with estimates of Samsung having sold 50 million smartphones in the most recent quarter versus Apple’s 30.5 million. I think Apple’s missing the big picture, by licensing its technology, the company could receive revenue on 80.5 million smartphones instead of 30.5 million.

Apple continues to innovate and gain momentum as highlighted in the company’sWorld Wide Developers Conference 2012 held on Jun 12, 2012, but anticipated announcements related to a new iPhone and TV did not materialize. A few highlights from WWDC 2012 include:

• sold out WWDC 2012 in 1 hour and 43 minutes, two years ago took eight days
• over 400 million accounts on the App Store with credit cards and one click buying
• over 650,000 applications in App Store
• 30 billion Apps have been downloaded
• over $5 billion paid to application developers
• App Store in over 120 countries with 32 more coming
• updating MacBook Air with third generation Intel Core processors also known as Ivy Bridge which can support up to 512 Gbytes of flash storage
• updating MacBook Pro with Ivy Bridge
• MacBook Pro has retina display – pixels so small cannot be seen by the human eye from normal working distance
• 66 million Mac users, 3x five years ago
• iCloud introduced in October has 125 million registered users
• sold more than 365 million iOS devices
• integrating Facebook into iOS 6
• integrating Facebook into Siri
• two thirds of mobile traffic comes from Safari via iOS

With Apple’s upcoming earnings release scheduled for July 24, 2012, an investor in Apple might consider protecting the position, at least temporarily, just in case the company’s results aren’t stellar. Apple has continued to execute and its stock price has reflected the company’s execution as shown below:

However, with Apple’s recent record of execution, any misstep by the company could result in a nasty surprise with respect to its stock price, as the expectations for the company are very high at this point. A protected covered call might be considered for Apple, as the strategy positions for a potential return, even if the stock price is stagnant, and provides for protection, in case the stock price drops significantly. A protected covered call may be entered by selling a call option against a stock and using some of the proceeds to purchase a put option for protection. The put option operates as “stock insurance”.

In a series of previous articles related to Apple, protected covered calls were considered for the company. Since the posting of the first article on April 24, 2012, an investor long in Apple stock would have realized a return of +7.6%. However, an investor using the protected covered call strategy would have realized a nice profit of +10.5%, a higher return and an investment protected via put options.

• Long Apple stock: +7.6% return
• Protected covered call: +10.5% return

Using PowerOptions tools, a number of protected covered call positions were found with a maximum potential loss less than 8% as shown below:

The 8% maximum loss value was used, as an 8% loss can typically be recovered fairly quickly using option income strategies.

The highest potential returning position looks attractive with a potential return of 2.8% (34% annualized) and a maximum potential loss of 7.3%, so even the stock drops to zero, the maximum potential loss is 7.3%. The specific call option to sell is the 2012 Aug 610 at $22.85 and the put option to purchase is the 2012 Aug 550 at $5.00.

Trade

• AAPL stock (existing or purchased)
• Sell AAPL 2012 Aug 610 Call at $22.85
• Buy AAPL 2012 Aug 550 Put at $5.00

A profit/loss graph for one contract of the Apple protected covered call is shown below:

For a stock price below the $550 strike price of the put option, the value of the protected covered call remains unchanged. If the price of the stock increases to around $670, the position can most likely be rolled in order to realize additional potential return.