Here’s why rising interest rates and falling implied volatility make Apple a perfect potential drawdown play.
Overall, stocks appear to be showing major resistance. $4200 is still a wall for the S&P 500.
The largest stock by market capitalization, Apple, is certainly no exception. Apple stock is where it was a year ago. The question is whether it goes even higher now.
Here’s a quick comparison of then (April 2002) versus now at Apple. And why now you might want to consider a relatively cheap sell buy.
The Fed has raised rates significantly over the past 12 months. Currently, the Fed Funds rate is between 4.75% and 5%. This time, last April, the fed funds rate was well below 1%.
The 10-year Treasury yield is also much higher today than a year ago. At the time, it was yielding less than 2.75%. Today, it is above 3.5%. Undoubtedly a significant rise in interest rates. Yet stocks like Apple don’t seem to care.
This magnitude of the increase in interest rates should cause a noticeable contraction in valuation metrics such as price/earnings (P/E) and price to sell (P/S). Instead, the AAPL P/E ratio is up a full point, from 27 to 28. The P/S ratio for Apple is virtually where it was a year ago, just a little less than 7.
APPL stock is back to similar multiples that have signaled highs in the past. The last time the P/E was this rich around 28 was last August, just before a tough pullback.
Given that the Fed has signaled that it is unlikely to cut rates anytime soon, a continued expansion in valuation multiples is unlikely from these current high levels. This will provide considerable headwind for AAPL stock over the next several months. Additionally, it is interesting to note that the magnitude of the current rally almost precisely equals the magnitude of the previous major rally that ended in August, as seen in the chart.
Implicit Volatility (IV)
Implied volatility has fallen significantly in Apple options over the past year. At the time, the $165 July-at-the-money put options carried an IV just below 33. 12 months earlier (for calls and puts).
How much cheaper? The table below gathers all the elements.
From time to time
- Now the July $165 put options have 91 days to expiration (DTE). Then the same puts had 85 DTE. All else equal, today’s put options should be more expensive since they have 6 more days to expiration (7.06% more)
- Now, AAPL stock has closed at $165.02. Then Apple closed at $166.42. All things being equal, puts today should be a bit more expensive as the stock is down $1.40 (0.84%)
- Now the July $165 AAPL put options are priced at $7.45. Then the July $165 AAPL puts were priced at $8.95. Why are put options today so much cheaper (16.76%) than a year ago?
- Now IV is at 24.97. Then IV was at 32.76. So the big drop (23.78%) in implied volatility makes what should be a bit more expensive now based on more DTE and a lower equity price much cheaper now based on a much lower IV.
Investors and traders looking to take a short position in stocks like Apple would be wise to consider the benefits of buying cheap put options. Defining the risk and lowering the cost of playing for a cashout makes more sense now than it has at any time in the last 12 months.
What to do next?
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All my wishes!
Editor, POWR Options Newsletter
Shares closed at $412.20 on Friday, up $0.32 (+0.08%). Year-to-date, it has gained 8.20%, versus a % rise in the benchmark S&P 500 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 Chief Options Strategist at ThinkorSwim and 3 years as a Market Maker for First Options in Chicago. He makes regular appearances on Bloomberg TV and is a weekly contributor to the TD Ameritrade “Morning Trade Live” network. His primary passion is to make the complex world of options more understandable and therefore more useful to the everyday trader. Tim is the editor of the POWR Options newsletter. Learn more about Tim’s journey, as well as links to his most recent articles.
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