Biting the Big AAPL

There are rallies, and then there are rallies.

It is not surprising when a small cap stock takes off and has a large price run.  After all, the volume is typically thin, the outstanding shares low, and it doesn't take much money to move these stocks.  These are the stocks that get halted on small rumors because there literally isn't enough shares available to meet the sudden surge in demand.

And then there is AAPL, which has gained over $100 per share in 16 trading days and is approaching a market cap of half a trillion dollars.  Yes, trillion, with a T.  What is going on here?  This isn't a penny stock that can be easily manipulated by a high school student with access to the Yahoo message boards.  This is a huge stock that trades tens of millions of shares each and every day.

Here is what you need to understand...

Yes, AAPL makes great products and their iPad is transforming the tablet business, and rumors of an iPad 3 announcement in March have the blogosphere working overtime.  However, that is not what is causing the price run up.

The stock market, and individual stocks, price in everything before the news becomes widely known.  This is what's called a "Ripple Effect."  News is reflected in the stock price before it hits the headlines.

And the big money sees what is going on with AAPL.  And as a result they are grabbing shares hand over fist.

And here is exactly what is going on.

AAPL has $100 billion in cash sitting in the bank doing nothing.  Literally.  It's sitting in T-bills and AAPL is known to have no desire to use that cash to buy big companies.  Sure they will buy the occasional small company to get their specific technology or patents.  But why waste their hard earned cash on something they could build better themselves?

And to top it off, thanks to hot, high margin products like the iPad, that cash mountain is growing every day, and will continue to grow in the future.  In other words, it's not going away.

What else can they do with that money besides just let it sit there doing nothing?

Simple...

Pay dividends.

So in one fell swoop, once they make the announcement (and they will, investors will pressure them into returning some of that cash) AAPL goes from being a growth company to a dividend stock.

The key piece of the puzzle here is this:  Most companies that pay dividends essentially stop rising in price.  Just look at MSFT.  This was the most amazing growth stories on the planet . . . right up until they started paying a dividend.  Since that time, they have traded sideways for over a decade.

So what gives with AAPL?

The big money is pouring into AAPL because they know that when AAPL finally announces that they will start paying dividends . . . then a flood of new buyers will pour into the stock.  These are the dividend buyers and there are a lot of them.  They aren't looking for price appreciation, they are looking for income.

The big money is buying AAPL right now so that when they do announce to the world that they will start paying dividends, they can then sell these newly higher priced AAPL shares off to the dividend investors.

Simple as that.

There is still time to participate in the run up in AAPL.  However, there is a better play here, and that play is to start selling out of the money call option credit spreads.

Why?

Because once the dividend payments are announced, AAPL will start trading sideways to down.  Have you ever heard the saying, "Buy the rumor, sell the news?"  Well, once the news hits, the price will already be "baked in" to AAPL shares.

For call credit spreads, I'm looking to sell the $530 calls and then buy the $535 calls as protection.  I'm selling this for $2.50, meaning that I will receive a credit of $250 in my account for every option I execute.  My maximum risk on the trade is $2.50 ($250 per contract) and my maximum profit on the trade is also $2.50 ($250 per contract).

Once the dividend is announced, the "price bubble" will be deflated, causing out of the money calls to expire worthless.  I'm happy to sell these calls out now, and collect the full premium as the price erodes.

There is buy the rumor, now is the time to sell the news . . . and sell the premium created by the rumor.  And that is what we are doing here.

Successful investing,

John Frederick Carter

Related posts:

1. Options Expirations Mean Money!
2. Time for a Rest
3. Avoid This Mistake When Buying Options
4. Making Money Playing the Gaps
5. Optimistic Start to 2012, But Confusion Still Reigns

Other posts by John Carter