This is why interest rate hikes and lower implied volatility make Apple a potentially perfect pullback put game.
Stocks generally seem to be surmounting major resistance. $4200 is still a wall for the S&P 500.
The stock with the largest market capitalization, Apple, is certainly no exception. Apple stock is where it was then a year ago. Whether it goes even higher is the question.
Here’s a quick comparison of then (April 2002) versus now in Apple. And why you might want to consider a relatively cheap put buy right now.
The Fed has hiked interest rates dramatically over the past 12 months. Currently, the Fed Funds rate is 4.75% to 5%. Last April, the Fed Funds rate was well below 1%.
The yield on 10-year government bonds is also much higher today than a year ago. At the time, it yielded less than 2.75%. Today it is over 3.5%. Undoubtedly a sharp rise in interest rates. Still, stocks like Apple don’t seem to care.
This magnitude of the increase in interest rates should mean that valuation metrics such as price/earnings (P/E) and selling price (P/S) should contract noticeably. Instead, the AAPL P/E ratio is up a full point from 27 to 28. The P/S ratio for Apple is in much the same place as a year ago, just under 7.
APPL shares are back at similar multiples that signaled tops in the past. The last time P/E was this rich around 28 was last August, just before a major pullback.
As the Fed has indicated that rates are unlikely to be cut any time soon, a further increase in valuation multiples is unlikely given the current high levels. This will create significant headwinds for AAPL’s share price in the coming months. In addition, it is interesting to note that the size of the current rally is almost exactly the same as the size of the previous major rally that ended in August, as shown in the chart.
Implied Volatility (IV)
Implied volatility in Apple options is down significantly from a year ago. At the time, the $165 at-the-money put in July had an IV of just under 33. Today, comparable at-the-money trading has an IV of about 25. This 25% drop in IV means option prices are now be much cheaper than 12 months earlier (for both calls and puts).
How much cheaper? The table below puts it all together.
- Now, July’s $165 puts have 91 days to expiration (DTE). Then the same puts had 85 DTE. All things being equal, today’s puts should be slightly more expensive as they have 6 days left to expiration (7.06% more)
- Now AAPL stock has closed at $165.02. Then Apple closed at $166.42. All things being equal, puts should be slightly more expensive today as the stock is down $1.40 (0.84%)
- Now the AAPL July $165 puts are priced at $7.45. Then the $165 AAPL placements in July were priced at $8.95. Why are the puts so much cheaper today (16.76%) than the puts a year ago?
- Now IV is at 24.97. Then IV stood at 32.76. So the big drop (23.78%) in implied volatility makes what should now be a bit more expensive based on more DTE and a lower share price now a lot cheaper based on a much lower IV.
Investors and traders looking to take a short position in stocks such as Apple would be wise to consider the benefits of buying cheap puts. Determining the risk and lowering the cost of play for a pullback makes more sense now than it ever has in the last 12 months.
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All the best!
shares closed Friday at $412.20, up $0.32 (+0.08%). Year-to-date, it has gained 8.20% versus a percentage increase of the benchmark S&P 500 index over the same period.
About the author: Tim Biggam
Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and 3 years as Market Maker for First Options in Chicago. He makes regular appearances on Bloomberg TV and is a weekly contributor to the TD Ameritrade Network “Morning Trade Live”. His main passion is to make the complex world of options more understandable and therefore more useful for the everyday trader. Tim is the editor of the POWR options newsletter. Read more about Tim’s background, along with links to his most recent articles.
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