We have moved well into earnings season and the overall story remains mixed. There is nothing definitive to show that the economy is either improving or getting worse, but is rather stagnant. Apple is one of the most watched and hailed companies in this generation, so when it reports earnings the world watches.
Apple (AAPL) announced quarterly earnings that (of course) beat expectations, as expected . However, the story was mixed and initially sent the stock plunging 20 points in the after-market session. The stock quickly rallied back to unchanged two hours later. So what in the earnings drove that kind of market volatility?
One concern is that Apple’s gross margins declined, down to 37% from 40% a year ago, and are expected to continue to decline. That is a significant adjustment and one can’t help wonder, are Apple products as profitable as we initially assumed or is it just mass sales volume that is driving the bottom line profits? This leads to a rather interesting question, are they trying to pump sales volume because the new product lines are costing more to make and are they also lowering prices (slightly) to compete with Android products? Regardless, the iPad Mini 2 and iPad 2 are still (even with the new price points) significantly over priced against the competition.
The Apple earnings over the last 4 quarters has seen gross profits decline and margins shrink. Sure the sales were solid, but if margins are shrinking the company needs to ramp sales to offset the shrinking margins if it expects to grow.
While iPhone sales were solid, iPad sales came in a light (down 400,000 units). The company did state they had a backlog, and while that always sounds like a great excuse for not delivering (blaming it on demand), the fact is, at the end of the day, if you can’t deliver, and you don’t get paid. The spin from CEO Tim Cook was that he expects the [overpriced] redesigned iPads will deliver an “iPad Christmas”. He had better hope so, because he will need sales volume to offset his shrinking gross margin forecast. They will need to see an 8% sales growth rate in their product lines next quarter to offset the shrinking margins. No doubt they can do it and they have reported blow-out sales before; however, this is a very short (the shortest on record) holiday sales season, with only 26 days between Black Friday and Christmas (6 less than last year). They will need to move a lot more inventory and faster than they did last year. That is challenging math, 23% few days to move product and the need to increase sales volume by 8%. Of course now, if anyone can do it, it would be Apple.
There was some good news in the Apple earnings report, the company saw top-line revenue increase to $37.5 billion, up from $36 billion a year ago. No doubt the quarter’s earnings significantly benefited with the new iPhone launches, which sold 33.8 million units (a jump of 26% over the same time period last year, but much of that is attributed to a new release). The problem with measuring growth over periods of time is that one doesn’t usually take into consideration market saturation levels. Any new release will also see net shipments jump on the front-end, especially compared to sales volume over other periods where there were no new product launches. iPhone sales will remain strong into the next quarter, but will not see the same increase over this last quarter, since the iPhone has been released. This leads to the push of the new iPad product releases to help keep the net sales volume strong into the next quarter. Remember Cooks message, It’s going to be an “iPad Christmas”?
The Apple Fan boys will need to come out in force!
Apple Trading Strategy
I am often asked what kind of strategy to take in these earning cycles. I personally never like to take a big delta bet (long/short underlying stock) heading into earnings on these high volatility stocks. Instead I take an options position to play the volatility. The advantage of trading the Apple earnings with options is that we have weekly options (expire on a weekly basis) and we get very high volatility.
Below is a diagram of the strategy I had been working on yesterday heading into earnings. The strategy is buying a Condor (looking for the stock to make a big move up or down). The problem with Condors is that you have to PAY money for them and if the stock doesn’t make that big move, you lose. In the strategy below I subsidized my Condor by selling a 2:1 ratio spread at the 475/470 put strikes. The net position has the risk equivalent of being long 20,000 shares if Apple stock falls below 470 by this Friday.
The strategy was put on for a net credit. If Apple stays between 505 and 555, this position makes only $3,000. However, if it moves down below 500 or goes above 560 (a 30 point move up or down) the position would generate approximately $20,000. The big sweet spot is down at 470 with a $120k profit potential, but the probability of this is low. Remember, the goal was an expectation of a 30+ move up or down and if it didn’t move I would still close out the position with a very small profit.
Well, coming in this morning Apple didn’t move much, well not below $500 or above $560. I still have the rest of the week.
Support & Resistance
I think we can get to 15,700 in the near future and perhaps further climb the wall of worry to go higher. However, it is really not moving higher on strong economic growth, strong top-line revenue growth, or an increase in price inflation. The rally is fueled by the Fed. How much so, I am not sure, but I would wager at least 50%, if not more.
We could see the NDX move higher. Apple’s earnings were mixed; nothing to get too excited about and nothing to be too concerned about. The overnight volatility was pretty huge, but this morning it seems to have calmed down. Perhaps we need to ponder over the earnings before we see any serious moves in the stock.
I would look at 1725 as short-term support if we pull back. However, so far there has been neither good nor bad news to really move this index. It is slowing ticking higher, but in a stalling fashion. The VIX is still holding up above 13, so I am not too concerned about a pullback yet.
The broadest index is stalled and just hanging in here, there has been no solid move higher or lower. The coiled spring of hidden volatility is building. I suspect we will see a big move up or down in the coming week.
Fed Meets! So what?
The Fed is meeting this week, but not getting much news coverage as I don’t believe anything will come of it, other than a quick “meet and greet” accompanied by finger sandwiches. The Fed has egg on their faces after the Taper debacle. Also, they are fighting continual pressure from some Congress members that still want a REAL audit of the books and more transparency. Add in the Larry Summers cheer-leading frenzy over the summer and this institution is looking like a bunch of monkeys. Of course, I would never call them monkeys, that is how Chinese officials have referenced our monetary institution and policies.
Meanwhile, Obamacare seems to be getting worse and worse. The website crashing, the 800 number is not working and now, according to several news stories, millions of Americans will be DROPPED from their current insurance and forced to pay up for a more expensive, but supposedly better coverage plans. Even Democrats are now coming out of the wood work to call, for a delay of Obama care, at least until they can get it fixed.
Add in some friction between the Clintons and Obama, as the Clintons are getting primed to run for 2016 and distancing themselves from the Obama debacles (IRS, Snowden, Phone Tap, Obamacare, Drone Strikes, etc.), and we are starting to see the Democrats now come apart with the 2014 election and 2016 pro-Clinton faction. Perhaps the Democrats are taking plays from the Republican vs. Tea Party play book. It’s amazing how a different a day makes. The media sure loves to drive that 24-hour news cycle.