The Apple Game-Plan for October

This is going to be a very long article that we’re going to update throughout the weekend. So please check back as sections are completed. We’re going to send out tweets whenever we complete a section. This is a very important article. Please do not skip this article. Read it in its entirety. I cannot stress how important this article is.

Bullish Cross Model Portfolios: The Importance of following our Models to the Letter
I didn’t get into the business of investment research to correct the stupid mistakes of some investors who simply just do not care to address the duel nature of market risk. The purpose behind Bullish Cross is to demonstrate to our readers how to make good overall investment decisions, to offer a directional framework for Apple and the financial markets, and to demonstrate how we would execute a well-hedged investment strategy. It’s also our purpose to put out earnings based research so that our readers can make good overall long-term decisions.

We’ve repeatedly mentioned over and over again that closely following the various Apple-based model portfolios to the letter is very key. That when we make a decision with regards to these portfolios, that decision is very carefully calculated and delicately executed to contemplate nearly every scenario that the market can throw at us. If you decide to deviate from the model, you’re likely to run into problems. Here’s what we wrote at 4:06 PM on September 21, 2011 which is the day Apple topped out and started its descent from the $420 level:

September 21, 2011 @ 4:06 PM — Here’s a picture of the NASDAQ-100 which is starting to look very very weak. This could put some downside pressure on Apple. I can’t stress how important it is to be well hedged against market risk at this point. This is why I think following the Bullish Cross 10-bagger strategy to the letter will at the end prove to be a very good idea. There’s times where I even deviate from the model for personal reasons. But the model itself will prove to be detached and profitable. The big reason I think the model will do its job is because I’m approaching it in an entirely mathematical way which is unaffected by fear or greed. When you deal with personal accounts, there’s a tendency to make decisions on the backdrop of fear and greed.

If you look at the 10-Bagger Model Portfolio, we took our NASDAQ-100 (QQQ) $54.00 puts at $0.99 a contract. For more than 3 days those puts saw prints at $1.00 and below. I saw those puts get as low at $0.70 a contract in the days after we took that position. The weekend before we put on that hedge, we stressed the importance to hedge against market risk through the use of index options. In Chapter 8 to the 10-Bagger Investment Report, we explained that we were entering what is traditionally the most bearish period for the market and that the QQQ was near the top of the range. You had 3 full trading days after we published that chapter to put on a hedge.

Even after we took that position, those puts were trading at a 30% discount. There is absolutely no excuse whatsoever to not have taken a hedge at this point. What’s really disappoint right now is that I know a lot of our subscribed simply decided to selectively follow our model. For whatever reason, some people simply only care to mitigate against the upside risk and simply just don’t give a shit about protecting against the downside in the market.

I don’t know how long it will take for some people to figure this out. Investing is all about addressing the varying of levels of risk in the market. There is upside risk and there is downside risk. There portfolio risk, market risk and stock risk. Investing is all about addressing these risks so that no matter what happens, you’ll be fine. If you don’t address both the upside and downside, then you’re just gambling. Go to vegas and bet on the roulette wheel. Better yet, take the money you’re spending on Bullish Cross and put it on Black. Because if you can’t understand or are unwilling to understand the dual nature of risk in the market, then there’s absolutely nothing that Bullish Cross can do for you. You’re pretty much doomed.

The reason I’m coming down hard on people here is for their own good. If you’re going to screw up, at least learn from the mistake and don’t do it again. When Apple is sitting at $420 and we’re saying it’s time to mitigate against market risk, mitigate against market is what you need to do. If that means selling a portion or half of your October spread then do that. We even gave a very powerful argument for why Apple was topping out at the $420 level and explained in 3-4 different occasions that $420 was the top of the range for Apple in the BC Live posts. If you didn’t do it last time, don’t repeat the mistake next time.

To be perfectly honest with you, people are going to make mistakes. I even make mistakes from time to time. It’s the learning curve that is important. If you have the tendency to repeat mistakes, you’re going to lose a lot of money. If you have a tendency to learn from that mistake, then you’ll be fine. Thus, anyone who didn’t put on a hedge on the QQQ this time, you better do so next time or I’m going to be pretty damn disappointed.

Because now I’m going demonstrate exactly the situation you’re in if you’re not hedged with those $54.00 QQQ puts, and how those who are hedged with those puts are now at a huge advantage. Remember, we bought those puts on September 19, 2011 at $0.99 a contract after we put out Chapter 8 on September 18. We bought those puts when the QQQ was in the low $56′s. On Tuesday, September 20, 2011, Apple and the QQQ topped out. That’s the following trading session. Yet, the QQQ had a high of the day of $57.35 which was almost a whole dollar above where we bought those puts. In fact, those puts dropped to an intraday low of $0.70 on the trading session.

Then on September 21, 2011, the QQQ again set a high of the day at $56.93 giving you yet another opportunity to buy those puts between $0.70 and $1.00 a contract. It wasn’t until Thursday — nearly 3 trading sessions after we purchased that protection — that investors finally got priced out of the protection. We’ll talk about the mechanics of the hedge, why we picked the $54.00 puts and what determines whether the protection is cheap or expensive. But that is completely irrelevant. I cannot sit here and give every single reason or negative reason behind why we do or don’t do something.

Truth be told, I could put out 10,000 pages of material and that wouldn’t even come close to scratching the surface of what goes into my decision making process. There is no way for me to practically reduce all of my knowledge, experience or reasoning abilities to the written word. There’s a reason why I chose the $54.00 puts and not the $55.00 puts and not the $53.00 puts. There’s reason why we took those puts on September 19, 2011 and not on September 10 or on September 30. There’s a reason we believed those puts were good at $1.00 but not really worth it at $1.50 given the diminished level of protection. There’s a reason we decided to buy open ended and unhedged puts and not a vertical put-spread. There’s a reason why we decided to buy puts on the QQQ and not on the SPY or on Apple specifically. There’s a reason why we chose to buy 250 puts relative to our 350 contract position for October. There’s a reason why we’ve decided to hold 68% of our 10-bagger portfolio in cash until mid-September.

It is completely unreasonable to expect me to reduce every single thought or reason behind every decision we make to the written word. No one could do that. I’m sure most of you are professionals and excellent at something. There’s probably a lot you can teach people. There’s no way you’re going to be able to transfer your full knowledge and experience to people in a short period of time. It would take you years to be able to do that. And with something as complex as the equity markets, shit. That’s going to take forever. There is so much in terms of experience that there is simply no practical way I can teach people everything.

The equity markets is very much as complicated as the human body and it would be like asking a physician to teach you to practice medicine in a few months. When we make a decision, we try to do the best we can to give the core reasons behind that decision. But you should understand right now that (1) there’s very little that is lost on me, (2) there’s very little that you’ve thought of that isn’t already on my mind and (3) whenever we make a decisions to hedge, it’s for a really damn good reason. Even if we don’t sit there and state every single reason for why we’re putting on an index hedge, you can bet that the reasons are very important.

If you start a comment with “Andy, have you thought of…” or if you start a comment with “Andy, what about…”, then it probably means you have certain assumptions about my level of experience that is likely to lead you into trouble. There has got to be a certain level of trust between us. For example, when I state that I’m going short the TLT for the long-term, you should understand that I’m fully aware of the fed’s plans to buy 20 year+ bonds. Yet, there’s a reason for why I don’t give a crap about the fed and their feeble attempts to keep rates low at the long end of the curve. I’m aware of operation twist and what is entailed in the fed’s strategy.

I’m limited in terms of time. I have to focus on what’s important. Giving every little detail for every decision we make it impractical. So there needs to be a certain level of trust between us. If you don’t have the built in trust, then don’t following the f’ing portfolios. Don’t just buy the October spread and then decide not to put on a hedge when we say its time to hedge. Especially when you have 3-days to do so and especially when we put out a detailed chapter in the investment report explaining why it was important to do so.

We even gave a proportion. 71.4%. 250 contracts on the QQQ versus 350 contracts in the $380 – $400 October call spread. The more contracts you have, the better. For example, if we had waited one more day, we could have used that $25,000 to buy 357 contracts at $0.70. That would be pretty much be a pretty flawless hedge.

Thus, I’m only going to bail you this time and this time only. If next time, you decide you don’t want to follow us in our hedge, then you are the one who assumes the inordinate amount of risk. Don’t expect me to create a framework for undoing a bad decision when I provided a perfectly good solution for confronting that risk to begin with. Right now, I think there is a substantial level of risk that Apple fails to close above $400 on October expiration given the increased level of market risk.

We’re going to lay out our October game-plan, but what you should understand right now is that there’s a fair chance that Apple does’t close above $400 at OpEx. We have laid out a framework for dealing with that. Chapters 5-8 in the investment report focus exclusively on hedging downside risk with (1) cash and (2) index options. Once we’ve laid out our directional framework for where we think Apple is headed for the month of October, we will then focus on how to deal with an unhedged October $380 – $400 call-spread.

Early October: The iPhone 5 Event
Let’s begin our discussion of the iPhone 5 event with some very general comments and a broad overview of how to approach any Apple media event. First, when I refer to the iPhone 5, I’m merely just referring the fifth generation of the iPhone and necessarily to the hypothetical iPhone 4S or hypothetical iPhone 5.

The first thing you need to understand is that in the vast majority of the cases — 10/14 since 2008 — Apple ends up “selling on the news.” So you should always expect that the stock is going to sell-off heading into these events. Planning otherwise is both naive and very stupid. Don’t invest with the idea that Apple is going to rally after these iPhone events.

The second thing that should be known by now is what determines the level of selling pressure is the market environment at the time of the event. If we’re seeing a huge sell-off in the markets and the environment is very bearish, expect the stock to slide — especially if Apple holds up ahead of the event.

During the 2008 financial crisis, you saw Apple get absolutely hammered ahead of its September media event as it fell 4.98% in the week ahead of the event and then fell another 3.95% on the day of the event itself and then another 11.42% during the week after the event. From the week before the event until the week after the event, the stock lost 15.8%. Remember, this event happened in early September ahead of the heart of the sell-off in the markets. The environment was just very bearish. If you haven’t done so already, you should go back and read an article we published in early July entitled “How the Market Environment Impacts Apple News.” The table below outlines Apple’s Performance in and around media events:

As we explain in that July article, the market environment is pretty much everything. If you go back and look at the September 2010 media event, Apple rose 0.09% in the week ahead of the event, 2.97% on the day of the event itself and 8.15% during the week after the event. Do you know what was introduced at the event? iPods. Who gives a shit right? The reason the stock was running before, on and after this event is because the market environment was very bullish at the time. We were getting huge introductions of capital into the financial markets through permanent open market operations by Mr. Bill Dudley and the New York Fed. On top of that, everyone knew we were getting QE2.

The market was in complete euphoria. That’s why they can buy up something as stupid and useless as an iPod in one environment and sell the crap out of the stock on something big like the iPhone. Remember, the iPod only makes up 5% of Apple’s revenue these days. It is no longer important as a revenue driver. It is important for the overall iOS platform, but not as a direct revenue driver.

The third thing you need to realize is that Apple’s momentum is also very important heading into these events. If the market environment is bullish, and Apple has heavy momentum going into these events, it is far more likely to be trading in the green on the day of and in the week following the event. In fact, don’t buy into the nonsense belief that just because Apple is down ahead of the event, that it means there will be no sell-the-news reflex in the stock.

That is not how it works. In fact, Apple was down 1-week ahead of their media events only in 5 out of the last 14 media events not including this past week. In every case, the stock was down significantly 1-week after the event. It’s because the momentum is very negative. In fact, the stock is more likely to see a heavy sell-off after the media event whenever it is down ahead of the event. Take a look at the table above. The biggest sell-offs 1-week after the event and on the day of the event take place when the stock is down 1-week ahead of the event. So if anything, it’s actually a very bad sign when the stock is red going into the event itself.

So what tends to happen is the stock just completely falls apart after the event is over. The rule of thumb with these media events is this: when the stock is beaten down, DO NOT EXPECT THE EVENT to bail Apple out.

In most cases, when the stock is down ahead of the event, you’re left with even more selling pressure after the event. The reason for this is simple. In most of these cases when Apple is down ahead of these events it is because the macro environment is usually pretty negative. So what tends to happen is the market doesn’t get anything major and then it just punishes the stock in the process.

Notice how so far I’ve introduced absolutely no discussion about what may or may not come out of the event in this article. That’s because what comes out of the event is completely irrelevant as to what is going to happen to the stock after the event. If you believe it makes any difference whether Apple introduces an iPhone 5 or iPhone 4S, then it means you have a very long way to go to understanding how the market functions.

If the iPhone 5 is introduced, Apple sells-off. If the iPhone 4S is introduced, Apple sells off. If the environment was very bullish right now, then we have a situation where: if the iPhone 4S is introduced, the stock rallies; if the iPhone 5 is introduced, the stock rallies.

So why in the hell do I really care what is introduced if it really makes no difference and has very little impact on the final result after the event? The focus should be entirely on the market environment and momentum than on what is introduced at the event itself.

For example, if the market is up several hundred points on the day before and on the day of the event, then that will help the situation. Apple will probably sell-off less than if the market was down 500 on the day. That’s because you want a more healthy market environment.

The only thing that could potentially cause the stock to rally on the event is if Apple introduces something novel and unexpected. It has to be something not already rumored about and it has to be something big. It has to be something that would add very substantially to its top and bottom line. A mere feature for the iPhone does not count. Unless that feature has the ability to cure cancel, iPhone aren’t really going to get the stock moving. Yet, suppose Apple were to introduce an iPhone 5 and the device completely exceeds all expectations as something revolutionary, then that could also get the stock rallying.

What you need to understand about these events and how the market functions is that the event is priced into the stock. It’s not some huge secret that Apple is introducing iPhones in September/October. So that is priced in. Everyone who wants in the stock given this known news is already in the stock. Everyone who doesn’t care about Apple and the iPhone is not in the stock and is not going to be driven into the stock because of the iPhone.

It’s not like people are going to be like, “OMG! Apple introduced an iPhone?!?!? What is an iPhone! I want in the stock now!” But that type of reaction will be seen if Apple introduces something novel and unexpected. The only other way we see Apple rally on and after the event is if the market environment and momentum is very very positive. Then they’re just really using any excuse to buy. I wouldn’t even say its that. It’s more of the fact that money is flowing into the market and participants are just stepping into the equity markets given the momentum. There’s no reason to “sell the news” because the overall equity markets are simply going higher.

So let’s take a look at the data. The one thing you should notice from the chart above is that there is a pretty big disparity between how the stock moved around these media events during the financial-crisis/recession era in 2008 – 2009 and how the stock trading in and around these events in the post-financail crisis era 2010 – 2011.

In the 2008-2009 era, the stock tended to rally huge ahead of these media events — with the exception of the fall of 2008 of course — and then sold off big on the day of the event and in the week that followed. In fact, in all of the seven media events/product introductions between January 15, 2008 and September 9, 2009, Apple sold off by 2.92% on average on the day of the event. It then saw an additional huge sell-off of about 7.74% during the week after the event. In five out of the seven events, Apple saw a 6%+ sell-off. That is pretty substantial in 1-week. Yet, in most of these cases the stock also rallied pretty big ahead of the event. On average, the stock saw a 5.85% rally in the week ahead.

But notice how these events in the 2008-2009 era were all overall very negative. The stock was either flat from the week before to the week after the event or down significantly. It would have been better had Apple not held an event at all. It would have been better for Apple to simply silently introduce their products without hosting some major event. It kind of sucks for investors, but that’s how the cookie crumbles. Barely rally ahead of the event, and sell-off big after the event.

Then after the crisis was squarely behind us, we saw a pretty big shift in how the stock reacts to these events. The first thing that is noticeable is that the stock no longer really moves in such violent swings before and after these events. In fact, look at the average pre-rally ahead of these media events between January 27, 2010 and June 6, 2011. On average Apple rallies 0.18% ahead of these events. The biggest rally was 3.12% ahead of the October 20, 2010 Mac event — which is partly also attributed to Apple’s earnings — and the biggest loss ahead of these events was the 2.73% drop Apple saw ahead of the iPad 1 event (that was partially spurred by the market correction at the time).

This time, if the stock closes flat on the day on Monday, that would put it down 4.8% which is the biggest “pre-rally” loss since the heart of the financial crisis. In fact, the last time we saw such a steep sell-off ahead of an Apple media event, the stock lost 3.95% on the day of the event and another 11.42% in the week after the event. When you look at the chart above, you can see that in the vast majority of the cases Apple is in the green almost across the board in the week ahead of these events. It is very possible that after the close on Monday, this could be the biggest pre-event loss we’ve seen since January 15, 2008.

If the S&P 500 is in fact at the beginning of its 2nd leg down to this correction, I think it’s possible that we could see a repeat of 2008 with Apple. I think we could see Apple crash down to the $350 level which indicates why it is extremely important to be well hedged heading into this period of time in the markets as we explained on September 18, 19, 20, 21 and 22 and why it’s important to hold a significant portion of your portfolio in cash — we explained last Sunday why it was important to hold 20% of your Apple-investment capital on the sidelines. Read “possibility #3″ to the September 26, 2011 Bullish Cross Weekly Summary.

You always want to have a level of cash on the sidelines that can be used to capitalize on situations like June 2011, August 2010, March 2009, January 2008, August 2007, July 2006. Notice how there’s a major opportunity to capitalize on Apple at least once every year.

So I think what you need to take from this analysis is that Apple is probably going to sell-off on the event. After the financial crisis, whenever the stock is up ahead of the event, it has generally resulted in a move higher on the event. Yet, when the stock is down heading into the event, it has tended to suggest further downside ahead. This time around, we’re down pretty significantly ahead of the event, the market environment is bearish and the Apple momentum is completely shot right now. So you should at least prepare for further selling pressure. We’ll get into why that will most likely open up a huge short-term opportunity in the section below on technicals.

But let’s take a look at and isolate iPhone specific events and see how the stock has tended to trade after these events. The first thing you should notice from the two charts below is that Apple tends to be up huge heading into the event.

For the iPhone 4, the stock rallied from $246.76 to $255.96 in the two week period ahead of the event which is up 3.73%. For the iPhone 3GS, we saw the stock rally a whopping 18.1% from $122.50 all the way up to $144.67 which is $22.00. Granted the whole market was rallying at the time as we were coming off the lows of the financial crisis, but we did still see a big rally ahead of iPhone 3GS event.

Even during the heart of the financial crisis and during the May – August 2008 sell-off we saw in the S&P, Apple still managed to put up a 2.47% gain as it rallied from $181.17 to $185.64 in the two weeks ahead of the event. That was for the iPhone 3G.

Ahead of the introduction of the iPhone 1 at MacWorld, we saw the stock rally 3.1% in the two weeks ahead of MacWorld. So every iPhone in the past was preceded by a significant 2-week rally. Yet, this time around, we have seen quite a significant sell-off in the stock partly due to the overbought conditions we saw when the stock was at $422 and partly due to the market weakness. The S&P 500 has seen an almost 10% correction over the past two weeks.

Apple has fallen from $411.63 down to $380.00 in the two weeks preceding this iPhone 5 event. That’s a 7.68% sell-off in the stock ahead of this iPhone event. What’s also interesting about these iPhone introductions is that though the stock is up huge heading into the event, in every case except for the iPhone 1, Apple was down on the event itself. It was also down even more in the day following the event as well.

But that is largely the result of a sell-the-news reflex. The stock did see a pretty substantial pre-iPhone release rally. So that should be the expected result. With something as big as the iPhone, it will be interesting to see how the stock reacts despite being down nearly 8% ahead of this event. My gut feeling tells me that it will be down on the event and that will be some sort of a catharsis low due to severely oversold conditions. We may get a retest of $370.

So to review. Don’t go into next Tuesday with the expectation that Apple is going to rally on the event. That has only happened in very positive environments or in situations where something truly surprising and novel has been introduced. You need a “one-more thing” secret surprise to get the stock to rally. What comes out of the event, does not matter. The media will say it matters. For example, if Apple introduces an iPhone 4S and the stock sells-off hard, you’ll have at least 100 members of the media not to mention about 5,000 to 10,000 retail investors, Seeking Alpha idiots, small members of the media and bloggers blame it on the iPhone 4S. That has nothing to do with it.

You can continue to believe that to be the case and come to realize after a few years that it really doesn’t make a difference and use that information to your advantage, or you can continue to believe that it does. Bullish Cross is focused on what is important. I’m not really going to deviate from that. I also by my subscribers to discuss the Steve Jobs scenario at least 30 – 40 times and either ignored the request or explained why it didn’t matter and I think it was clear that it didn’t matter. It’s the same thing here. I’m not going to waste my time speculating on what is being introduced because it is completely irrelevant to how Apple will perform on the event.

Please try to learn how to separate the agenda of the financial press and the reality of the financial markets. The financial press always wants to pin a fundamental reason to explain events in the market. In some cases, there is a fundamental reason behind such events. But in most cases, there are so many other and more important factors at work. When Apple sells off on this media event, the most likely scapegoat will be the iPhone 4S and even some of my subscribers will fall for the banana in the tailpipe. But you’ll learn over time what that doesn’t matter.

You never want to see Apple limp into a media event, because in most cases it means more pain is in the cards. What matters most is momentum and market environment. If Apple was sitting at $428.00 making fresh all-time highs as we head into the event and the market is sitting at 1260 I would be making a case for a continuation of the rally especially if it was clear the market had momentum behind it. As it happens, the market is melting down and Apple is limping into this event. We’ll explain why we think there is a limit to the downside given how over-extended the stock is and then we’ll discuss the framework for approaching the stock going into the next 15 trading sessions.

Apple Technicals: Where’s the bottom?
If there is anytime where I think a swing trade in your entire Apple position is warranted it’s whenever the stock flies above its upper bollinger band. I don’t make mistakes all too often, but I think the best play a few weeks back was to not only take a hedge by purchasing the $54.00 QQQ puts, but what we should have done is sold our entire October $380 – $400 call-spread position when Apple was at $420 and then bought them back when Apple reached $405.00 a share. Looking back from here, I think that was actually a far superior move given what history is telling us about Apple and the upper b-band.

That $15.00 sell-off was certain. Now everything between $405 and $370 is uncertain and I think if we had sold the position, we would get long again. Here’s what you don’t want to happen. You don’t want to be put in a position where the stock sells off as expected and then it rebounds all the way back up to the $420 level and now you’re out of the stock.

Yet, I think given this lesson here, what we will do in the future is if the stock goes outside of it’s upper b-band again, we’re going to swing trade our entirely short-term portfolio for the retracement. It’s just way too high of a probability trade to ignore.

I think overall it’s generally a bad idea to sell Apple or any investment as a swing trade. We’ve repeatedly explained why it’s always far superior to hedge instead of attempting to trade based on short-term expectations.

Here’s why I don’t like selling ahead of the belief that we’re going to see a sell-off. I don’t like it because there will be a time where we’re completely wrong. Where we completely mess up in our expectations. What happens if after we sell Apple at $420, it rallies to $430 and goes full retard overbought? Do we buy our shares back at $430? Probably not because it would be very overbought now right?

Well what happens if it’s unrelenting and the stock runs from $430 to $445? Now what do we do? What happens if we get a sell-off back down to $437.50 and that takes us out of overbought territory and now the stock rallies back up to $448.90? What now?

That is the essential problem with thinking you can time the top. Yet, that being said. I think when it comes to Apple and the upper b-band, there’s now clearly enough evidence to suggest that the stock will sell-off after trading above the upper b-band. Reaching the upper b-band by itself is not enough. The key is seeing it go above the upper b-band.

If you go back to our Apple daily commentary on September 20, 2011, you’ll see that we make a compelling case for why we believed Apple was going to sell-off back down at least to the $400 level and that we would see $3XX again. If you read the 2:00 PM update to the September 20, 2011 BC Live post, you’ll see that we lay out several different reason for the incoming sell-off including this chart of Apple trading outside of its b-band top. The next trading session Apple set a new all-time high before closing in the red. It then proceeded to sell-off for the next 7 trading sessions losing $40.00 in the process.

I think a lot of money can be made trading the upper b-band. I think that is the best place to put on cover if you’re doing a leg-in strategy and it is by far the best place to sell a position if you want to do a swing trade. Think of it this way. When Apple reached this level, that’s where we put on our hedge on the QQQ. We bought the $54.00 puts @ $0.99 a contract on September 19, 2011 — the day before Apple topped.

Something we could have and should have done is also sold at least half if not all of our October $380 – $400 trade. I think that spread lost like $3.00 in value between where it was trading at in the $420′s and where it was trading at when Apple was in the $400 – $405 area. That’s a trade we’re probably now more inclined to make given the history of the b-band going forward.

Here’s the current and updated chart of how Apple trades after moving above its upper b-band that we originally posted on September 20, 2011. As you can see, the stock has taken a substantial hit that is not altogether different than what has happened in the past.

On earnings, Apple briefly traded above its upper b-band and saw a pretty significant sell-off as it lost $50.00 from those extreme overbought conditions. In October 2010, the stock lost 20-points over a 10-day period right after trading above its upper b-band. In April 2010, the stock lost nearly $78 after trading above its upper-band on breakout earnings. Obviously a large part of that sell-off was the flash crash and conditions in the market. But we still saw Apple kick-off that sell-off well ahead of the flash crash. Finally, we just saw a $40.00 8-day correction after the stock traded above its upper b-band on September 20, 2011.

Now what’s interesting here is that the lower b-band sits at around $370.00. I think if we get that sell-off, that will put in a firm bottom in the stock. As you can see in this chart above, in many instances the stock sees a steep sell-off after reaching its upper b-band and either bottoms at the middle b-band or at the lower b-band. I think if we see a sell-off down to that $370 level, it will open up an extraordinary buying opportunity and we’ll end up seeing a very sharp rebound probably up to the $400.00 area. That’s a $30.00 bounce which is quite significant.

Aside of the B-Band analysis which basically indicates that the $370 area is probably an absolute low for the very short-term, we have other evidence which suggests that we’re nearing the low. First, we are oversold on the 60-minute chart. What’s very interesting about the 60-minute chart is that unlike the daily, oversold conditions on the 60-minute tend to be a pretty good indicator for a reversal. That’s not really the case on the daily chart. If you take a look at the 60-minute chart below, you can see that the last few times Apple saw a steep decline, they all ended right when the RSI dipped below 30 on the 60-minute chart.

Now here are some other very interesting aspects of the 60-minute chart. First, that when we get oversold like we have, there tends to be a pretty significant snap-back rally. I think that rally could take us right above $400 a share after we test the $370 level. In fact, I’m expecting to see a test of the $405 area on the rebound.

The second thing which should be recognized right away is that we have a re-test of the symmetrical triangle upper trend-line. If you remember what we’ve said about symmetrical triangles in the past, there tends to be a re-test of the upper trend-line after the breakout. This could very well be it. We’re literally sitting right at the upper trend-line.

Finally, as you can see Apple is trading in a very organized down-trend channel. This has the tendency to be bullish eventually. In fact, there’s a tendency to see a reversal after 3 touches of the lower trend-line. We’ve seen two touches already. But I’m expecting to see four. In fact, I think it’s starting to become very clear as to where Apple wants to go and it makes sense with both the macro environment and the iPhone media event.

What you’ve seen us draw in the chart above is precisely what I expect to see. But let me tell you, this is overall great news. We have essentially 15 trading sessions until options expiration and this is precisely when you want to see Apple get its weakness out of the way and put in a bottom. Trust me. This had to happen. We didn’t want to see it happen too late and not too early. I think right now, it’s perfectly on schedule. There’s a cycle in the way Apple trades. It trades up and then down for a period.

Right now, we’re nearing the end of that down period. The stock has lost $40.00 in just about two weeks time. That is a significant sell-off. I think we could see the total loss hit just about $55.00 right at the exact peak low. Then we’ll see a $35 – $40 bounce over the ensuing 11 – 12 sessions including earnings. The two charts below are illustrations of what I think we will see over the next few weeks time. Notice that we have been pretty proficient at being able to predict very very specific moves in both the S&P and in Apple. I would be surprised if we get very close to what I’m outlining here:

This is a interesting concept of what I think is also very possible over the next 15-trading sessions. Here’s a chart of the daily which shows one particular outcome from now until options expiration three Friday’s from now. Here’s what I think could very well happen.

First, for the rest of this week, I think we could see Apple sell-off a bit on monday. I think we can close the session down about $5-$6 into the $375 – $376 area. Then on the iPhone event itself, I think that’s where the stock could actually put in a final bottom.

Here’s what I envision as potentially happening. I could see the stock down pretty significantly as we head into the event. We could even be down flat heading into the event. But as the event comes to a close, you’re going to see a very significant sell-off. I can see either one of two things happening on the day. We either go into the event flat on the day to down slight which turns into a $10.00 sell-off down into the $365 area or we could be trading down about $5.00 on the day as we head into the event and then see an additional $5.00 of selling pressure right as the event is concluding.

Now here is what I think will happen next. I think that we get down to the $365 level maybe around 2:00 PM EST and that will mark the absolute short-term bottom for the stock. In fact, I think what will then happen is you will see the stock make up $5 – $7 in the last two hours of trading. The low of the day will be something like $365 which is way below the b-band bottom and then you’ll see a close above that b-band bottom in the $370 – $372 area. I think in the next trading sessions we get a retest of those lows maybe briefly either in the morning or mid-morning. Yet, after that retest which can get as low as the reactionary low on the event, we get a bounce all the way up to the $375 area and actually close the day in the green — up $2 – $5.

Then on Thursday, we could see the stock begin its rally. I can see the stock close up nearly $10.00 on the trading session which will put it right at the $385.00 level. Then on Friday and on the following monday we push to $395.00. From there, takes a hit on Tuesday, Wednesday and Thursday which allows the stock to re-test the $380 level. Then on Friday, I can see a huge surge of buying interest ahead of the earnings announcements. This will close the stock right near its $393 resistance level. Then on Monday, we see the stock test the $398 – $399 level with a close at $405.00 on earnings day. Then if earnings are good, I think we can open up $20.00 at $425.00 a share followed by a sell-off of $15.00 on the session to close the day at $410.00. Then for opex I can see the stock close at $400.00 a share for max pain.

That I think is a very plausible outcome. Mostly because that’s the type of reaction we tend to see to such oversold lows in the market. Moreover, it is very common to see the stock set-up for fresh all time highs when it heads into earnings. That means closing at a price that would put it in a position to test those highs. I think that close is $405.00 a share on Tuesday, October 18, 2011. The chart below lays out one idea of how things could play out over the next 3-weeks. Remember, October OpEx is exactly 15-trading sessions away.

Again, this is all based on Apple’s technical picture. The problem is that the market technicals are far far more bearish than Apple’s technicals. We could be heading for a major sell-off in Apple if we get a huge leg down in the markets. This is why it is extremely important to have about 20% of your cash on the sidelines. Because if we get this huge leg down in the markets and Apple decides it wants to start performing with the market again, it’s going to open up an extraordinary buying opportunity better than we had in June. In fact, it will be the best buying opportunity we’ve seen since the lows of the financial crisis.

We explained this very carefully in last Sunday’s Bullish Cross Weekly. If we get this sell-off there are going to be multiple 10 and 20 baggers in the market. For example, if the $550 – $600 call-spread for 2013 drops to $2.50 a contract, that opens up a potential 20-bagger. There’s a very strong chance that Apple closes at $600.00 in January 2013. Right now, that spread is trading at around $7.50.

But if we get a big enough drop in Apple as result of the macro environment, that opportunity might arise. We could see a 10-bagger in the $500 – $600 spread. So you want to have capital on the sidelines in case this happens. We’re going to have a lot of very good strategies in place in the event we do get a major sell-off in Apple. You have to view these types of events as great opportunities in the market. Not as a bad thing. For example, right now the best we can do is a 10-bagger over the course of multiple trading in a relatively higher risk situation right?

Well if Apple sells-off down to the $325 or $335 level as a result of a move down to the 1,000 level on the S&P 500, then there are going to be straight forward easy 10 and 20 baggers both in the 2013 spreads and in the 2014 spreads. If you have 20% of your Apple specific capital on the sidelines, you’ll be put in a position of being able to capitalize on major investment. Even if you took a drawdown in some of your other long-term positions, so what? It’s not like the $400 – $500 call-spread is at much of a risk as a result of a short-term decline in the market. We have far more than a year until expiration. Apple will probably be sitting at $550 to -$650 by the time we get to 2013. $750 by the time we get to 2014.

So you kind of actually want to pray for such a situation. It’s no big secret that I’m starting a fund this month as the vast majority of you are probably well aware. If Apple is sitting at $350 when I start my fund. Wow. That’s all I can say. We’ll be able to do some extraordinary things. So it’s important that you have that cash on the sidelines, locked loaded and ready. These opportunities always arise. Year after year there’s always a massive opportunity. The chart below outlines Apple major support lines on the way down. We have $355.00 which is massive support created over 4 different occasions during the last year.

Then after that support level, the next nearby major support sits at $335.00. After that it’s $325 and then $310. You know, I should point out that if Apple traded at $310.00 after it reports earnings in October, the stock would trade at a 10.51 P/E ratio. That would be a first in over a decade I believe. That’s just some food for thought.

The reason I have to keep bringing this up is because anytime we have a situation like this where the market is sitting at a very fragile state and where Apple has sold-off by the highest amount ahead of a media event in 4 years, it really does set-off an alarm. We’ve seen this countless times before. Apple could easily turn south in a hurry if the market buckles and loses support.

Alternatively, we’ve seen Apple outperform for the month of August. The S&P 500 could tank to 1040 and Apple can be sitting at $440.00 saying hello to everyone from the bell tower. It’s very hard to say which will happen because historically Apple has tended to perform very poorly in such huge sell-offs. Also, the fact that it underperformed last week for the first time in a while now is a little disconcerting. So you have to be aware of the fact that we could get an epic crash.

The October $380 – $400 Call-Spread Framework
Right now, this Apple weakness is all very short-term in nature. If you even brought up a question about Apple’s valuation this weekend, I’m disappointed. There’s no question of Apple’s fundamentals, Apple’s valuation, Apple’s earnings, Apple’s future earnings and Apple’s future value. Apple is headed straight for at the very least $500 a share by January 2013. It will probably be trading well above $420 in January 2012 and above $450 by April. What we’ve over the last 7-days is just short-term weakness. Not a reason to cast any shred doubt whatsoever.

In fact, it worries me a little when I read the comments. Because it indicates to me that many of my subscribers are very fickle when it come to Apple. This is nothing. All we’ve seen is a minor pull-back and we start to get people questioning the fundamentals. WTF? What’s going to happen if the stock tanks down to $310 a share? If you bail, you’re just being a complete idiot and leaving probably hundreds of thousands if not millions on the table. Just let me take care of the earnings, valuation and fundamental aspect. You don’t ever want to buy into the short or intermediate bearishness, and conflate that with the long-term outlook. Bad idea.

The point here is this. That the only thing we’re concerned about right now when it comes to Apple is our $380 – $400 October Call-Spread we’re holding in our Apple 10-Bagger Model Portfolio. There is absolutely no concern with our January $400 – $420 spread which we bought on Friday or with our April $410 – $430 spread which we bought a few weeks back. We’re not very concerned with either of those position. We’re also not concerned with our January 2013 $400 – $500 call-spread that we bought right at the lows in June for a $17.00 cost basis. Those things are up nearly 100% right now. So we’re not really concerned with that. We are concerned, however, with how to deal with our October $380 – $400 call-spread.

So let’s focus on what we’re going to do with our $380 – $400 call-spread in light of this recent weakness in the market. As we explained above, we expect Apple to sell-off pretty hard on the iPhone event. We also think we could see a pretty significant sell-off on the NASDAQ-100 this week.

In fact, if we get a full 2nd leg down on the S&P 500, and see a move toward the 1040 level over the next few weeks, the NASDAQ-100 is very likely to fall to at least the $46 – $47 level. If we get a sell-off down to the $46.00 level, that would result in our $54.00 QQQ puts rising to the $8 – $9 level. It will probably have a $1.00 premium given that its so deep in the money and it will likely be trading close to a delta of 1 i.e. 1-to-1 with the options.

As many of you know, and for all you newcomers this weekend — every time there’s Apple something Bullish Cross has a surge of subscribers — we purchased the Apple $380 – $400 October call-spread about a month ago at a $9.26 cost-basis. When Apple reached around $420 a share two weeks ago, we purchased a hedge to that position.

I was growing increasingly concerned that the NASDAQ-100 was about to undergo a major correction from a rising wedge pattern that it was developing. So we purchased 250 $54.00 QQQ October puts at $0.99 a contract. Thus, we’re holding 350 October $380 – $400 call-spread contracts at a $324,370.00 cost-basis and as a hedge against that position we are holding 250 QQQ October puts at a $24,750.00 cost-basis.

We believe that this hedge is going to work beautiful to mitigate any potential loses to the downside while giving us the opportunity to double our money. If Apple closes above $400.00 on options expiration, then our $324,370.00 investment in the October spread will be worth $700,000.00 while our $24,750.00 hedge would likely be at zero. No big deal because we set aside $350,000 for this thesis + insurance and so if we double our money, then great! We consider the hedge as part of the cost to insure our investment. But our primary bet is not the insurance policy. It’s the $380 – $400 spread.

Now let’s see what happens if we end up getting some brutal-ass sell-off on wall street over the next few weeks as many (including myself) now expect. If we got a sell-off and full second-leg down in the markets, our QQQ puts will rise to $9.00 a contract. That is my expectation. If they rise to $9.00 as a result of the QQQ crashing to $46.00 by October expiration, our QQQ puts would be worth $225,000.00.

If this sell-off happens sooner rather than later, then here’s what I suspect we will see. The $400.00 October calls for Apple which we are short will likely fall dramatically. In fact, I think the fall in the $400 calls will exceed the drop in value in the $380 calls which we are long and there will be a moment in time during the next three weeks where it is possible that Apple could be down $7.00 while our spread is actually in the green on the day!!! Here’s why. As Apple gets further away from $400.00 it becomes less likely that the stock will be able to reach that level even with the support of earnings.

For example, suppose Apple were to fall to $360 a share on Friday. If that happens, while people might think that Apple $380 after earnings is easily accomplishable, investors could very easily lose complete faith in Apple $400. If that is the case, you can see the $400.00 completely deteriorate while the $380 could end up holding a lot of value. There is definitely going to be a premium in the $380 calls because when you have a huge event like earnings, there is always the possibility of the stock rising $20 – $30 points. So they will bid up the $380′s. But obviously, there’s little chance that Apple will be at $450 on earnings now right? Like now that Apple is trading down here in the $380′s, no one believes we’ll be at $450 on earnings anymore.

So if you look at the October $450 calls, they’ve completely fallen apart over the last few weeks. Well that is exactly what we could get with the $380 calls versus the $400 calls. We could see rapid deterioration of the $400′s while simultaneously watch the $380′s hold value. We could see the $400′s down $3.00 on the day and see the $380′s also down $3.00 on the day at the same time as a result of Apple being down $10.00. Notice, the spread wouldn’t have changed value in this scenario. So even though Apple, the spread is flat.

Well I think we might see something like that happen during this sell-off. Right now, the $380 – $400 spread is trading at $8.60 as of Friday. Our QQQ $54.00 puts are trading at $3.10. In total, the value of our $350,000 investment stands at $378,500.00. So we’re actually up $28,500 on our $380 – $400 call-spread + insurance. Our $380 – $400 spread is worth $301,000.00 and our $54.00 QQQ puts are at $77,500.00. If it weren’t for our protection, we would be down right now. We would be down $25,000. Instead we are up roughly $28,000.00.

If we got a catastrophic sell-off, I think that our $380 – $400 spread would drop to about $4.00 if Apple dropped to $360.00 in the process. If that happened, our $380 – $400 spread would be worth roughly $140,000.00. Yet, as we explained above, we think our QQQ puts could be valued at $225,000 in the process. Thus, overall our investment would be worth $365,000.00. We would be up $15,000.00. I think at a minimum, the QQQ will drop to at least $49.00. If that happens, we would be up $150,000 on the QQQ puts. So we would mitigate most of the losses.

This is why it was very very x1,000 important to hedge when we explained in great detail how this scenario could end up playing out. Now it’s playing out as we explained, and every day Apple and the QQQ drop, is another day we mitigate our damages.

If we had a scenario where the QQQ dropped to $46 and Apple fell to $360 which resulted in us breaking even on the trade, here’s what we would do. If Apple fell to $360.00 a share, the January $390 – $410 spread would very likely drop down to around $5.00 a contract.

We would sell our $380 – $400 October spread, sell our $54.00 puts and then buy the $390 – $410 or $400 – $420 spread at $5.00 a contract. That would would do a few pretty big things for us. First, it would buy us a tremendous amount of time. Second, we would get the same exact result as if we were holding the $380 – $400 spread and Apple expired in the money and we used that capital to roll over into the January $390 – $410 or $400 – $420 spread.

Instead of trying to double our money in January, we would be making a bet for a 4-bagger. That is the same exact result. $350,000 in a 4-bagger is the same as $700,000 in a 2-bagger. $1.4 million would be the result if Apple closes above our upper strike at January opex.

So that is what we would do here. That is the game-plan. Right now, everyone who is participating in this 10-bagger investment strategy and who followed us closely enough to be smart enough to hedge when we called for it — you had three full days to make that decisions even at a greater pricing advantage than bullish cross — you actually want to see the market either tank hard or rally hard. You don’t want to see dilly dallying.

If the market is down 500 on Monday and the NASDAQ-100 falls under $50.00 a contract, you are stoked! Especially if Apple tanks with the market. Here’s why. We essentially want to get the hell away from October at this point and we would rather move into a January spread.

We need a January spread that will essentially get us to the $1.4 million result in January right? Suppose the QQQ tanked to $49.00 by Tuesday. Our $54.00 puts would rise to $6.00. That would put us at $150,000 for the QQQ puts. If the Apple $380 – $400 spread only fell to $7.00 in the process, that would put us up to $395,000.00. We would have $45,000 in extra capital right? Well that means if we want to get to $1.4 million form there, we only need a 3.5 bagger on that $400k.

If the $400 – $420 January spread fell to $5.80 at the same time, we would probably call it a day. We would sell our $380 – $400 spread at $7.00 and sell our QQQ puts at $6.00. Then we would use that capital and buy the January $400 – $420 spread. We already succeeded on the October spread believe it or not. Because we’re not in the position to get our $1.4 million which is the goal in the January spread. It doesn’t matter how we get there as long as we get there.

So when thinking about the game-plan over the next 15 trading sessions, we’re going to want to either see a situation where either Apple and the market bottom and we get a rally, or we get steep sell-off that puts us in a position to be able to exit our $380 – $400 spread and roll over into a January 4-bagger spread. That is a great plan overall. If that means finding a 3.5 bagger at $400k then great. If that means a 2.8 bagger from $500k, then that’s also fine. Remember, the goal is to get to $1.4 million in January in a spread that we have confidence will get us there. All of this can obviously be brought down to scale with a little math.

But the principles we’re using here is all that is important. Everyone who bought the $380 – $400 spread when we bought it and bought protection when we bought that protection should be relatively green right now. This means there is nothing wrong with taking the more conservative road.

Here is one alternative strategy which I think is actually perfectly fine. Things are now starting to get pretty risky. The one thing that could really hurt us is to see Apple separate from the market and underperform. For example, suppose on Tuesday, the NASDAQ-100 is up $1.00 and Apple is down 5%. Our hedge is worthless in this situation. Remember, the reason we decided to hedge market risk instead of Apple risk is because we didn’t view Apple as being at any high level of risk of underperformance. We expected either market performance or outperformance. This means hedging against market risk in case we saw market performance + market sell-off.

The situation which isn’t hedged right now is underperformance. Anytime Apple underperforms the market, it just means we’re getting our butts kicked with any mitigation. So there is that risk on Tuesday at least. Now here’s an alternative strategy.

You give up on the October $380 – $400 trade, sell the position and the October $54.00 puts. That should put you up 10% or so at least if you took positions when took them. Then you take that capital and move it into a January position for a 3-bagger maybe. That would result in 50% less gains between October and January. But what you’re getting for that 50% reduction in gains is a signifiant reduction in risk. You’re buying time.

If Apple tanks and the market tanks, we’re fine. If Apple rallies and the market rallies, we’re fine. If Apple rallies and the market tanks, then we are super fine. If Apple tanks and the market trades sideways, we’re screwed. If Apple tanks and the market rallies, we’re screwed. If both the market and Apple trade sideways over the next few weeks, we’re screwed.

So that’s the issue here. We need to see a violent swing in one direction or the other, and we need to see at least market performance out of Apple. If we don’t get a big rally or a big sell-off or if we get underperformance from Apple, then this entire trade could be busted. Thus, in a sense it is entirely up to the individual investor whether they want to take that risk. The risk to the October $380 – $400 call-spread position is: (1) sideways action from Apple + Markets; (2) Apple underperformance.

If you get those two results, then the portfolio will end up losing money on the trade. So once again. One alternative is calling it a day and selling both the $380 – $400 spread and the QQQ puts, and using that capital toward a January spread. That choice is up to the individual investor. Some may want to take the risk, while others won’t.

We are going to monitor the situation and see how things go. As long as we’re getting heavy selling pressure in the markets, then I think we’re ok. But if we start to see a slowdown in this selling pressure, I fear that Apple can start underperforming and start to play catch-up with the overall correction. That would be some shitty timing.

The October $380 – $400 Call-Spread Framework for Those Who Didn’t Hedge
As promised, I explained above that I would lay out a different framework for those who decided not to take a hedge. Here’s precisely what you did when you decided to not hedge against market risk. You assumed that market risk. You decided to embrace it and hope that we didn’t get a sell-off. That makes very little sense given that we explained a sell-off was coming. There really much of a “what if” in this scenario. It’s a tornado coming toward town and an insurance provider asking you if you want cheap tornado insurance and you declined.

But it is what it is. Now here’s the framework. We have 15-trading sessions until October expiration. If the market tanks, then you’re probably screwed. If the market doesn’t tank, but if Apple starts to weaken as a result of this iPhone event, then you’re screwed. Right now, there is only 1 result which can help you out. And that is if Apple bottoms and then rallies to $400 a share. We explained above that there is a very fair chance that we see this happen.

The lower b-band sits at around $370 a share. I think we could see Apple sell-off down to that level, fall under the b-band intra-day, bottom and then get a snap-back to $405 a share. Remember, at this point the stock has already lost $42.00 or just about 10% in a little under 2-weeks. That’s a lot of selling pressure.

But we have seen the stock lose 50% of its value in 1-month before. We’ve seen that happen on multiple occasions. So that is a huge risk you take. On the one hand, Apple is oversold and due for a bounce. If that bounce happens — which I think is now pretty likely — you will have the ability to exit the position in the green.

I think there is also a very good chance that the stock will close above $400 at options expiration. There’s a great chance of that happening especially because of Apple’s history on earnings. As we demonstrated in our earnings compendium which we will once again be analyzing very soon, Apple has gapped up higher on earnings in 8 out the last 9 quarters including last quarter. So there’s a very strong chance that Apple will run into the result and gap-up higher after the results. There will be good opportunities to sell the position.

Moreover, you also should remember that in order to break even on the trade, you merely need to see Apple at $390.00 at expiration. If it closes at $390.00, the $380 – $400 spread will be at $10.00. If Apple is anywhere near or above $390 during option expirations week, you can expect to even get a little premium.

I can tell you that October earnings are going to be absolutely blockbuster. You’re going to see yet another blowout in earnings. Apple reports earnings on Tuesday and on Wednesday, it will have a TTM of $29.50. At $390.00 a share, Apple would trade at a 13.22 P/E ratio. At $380.00 a share — which would result in the options expiring worthless — Apple would trade at a 12.86 P/E ratio.

So that becomes the issue. Do you think Apple can trade at a sub-13 P/E ratio for a short-period of time? If you’re not hedged, the only thing you can hope for is that the market puts in a firm bottom, and that Apple trades exactly as I expect. You need to see this Apple weakness come to swift end with the iPhone event.

Thus, the framework for anyone didn’t put on a hedge is you take on the risk either way. You have now put yourself in the position of significant upside and downside risk. Almost certainly the decision you make, won’t be a good one. If you sell your position, Apple could very well run ahead of earnings and be at $420 two days before expiration. If you hold your position, you run the risk that Apple falls apart with the market on this second leg down that we are expecting now.

Now here’s the silver lining. I think it’s pretty good silver lining actually. I’m good what I do now because I’ve had my share of huge gains and huge losses. I’ve taken my beatings and now I’m at a point where I’ve crossed a certain threshold where the market has essentially become my bitch. I have a pretty high level of confidence in my abilities now, and that confidence helps me see through all of the nonsense which in turn helps me make very sound decisions.

Right now, if you’re in this position where you’re unhedged, you need to understand that this has now lead you to being exposed to unlimited upside and downside risk. The idea is to reduce both as much as you can. If you sell your position, you have unlimited upside risk. If you hold your position, then you have unlimited downside risk.

You can’t really buy protection at this point because it will be very expensive to do so. The $54.00 puts on the QQQ were at $0.99. Now they’re at $3.00. Best case scenario, they triple in value to $9.00 if the QQQ absolutely crashes. But there is a lot of risk that this doesn’t happen. We could see the QQQ rally and Apple tank. That’s very possible. That’s why you can’t really buy protection when the $VIX is sitting here above 40. You are just making the situation worse for yourself.

It took me a very very long time to realize that you need to always protect against upside and downside risk. Always have to do so. That means holding 20% of your long-term portfolio in cash. If you have $1m allocated to Apple, $200k should be on the sidelines for the OMG Apple’s at $310.00 scenario.

Likewise, when you’re dealing with short-term positions, you need to be thinking along these lines:

1. What happens if Apple rallies to the moon?
2. What happens if the market crashes?
3. What happens if Apple crashes?

You need to have a framework put in place to handle each of these different situations. Going forward, you should use this situation as an important lesson on why you need to hedge. If you look at chapters 5-7 in our investment report, we spend a great deal of time explaining why our cash position acted as a hedge in case this very scenario we are in right now happens to come to pass. We then spent chapter 8 explaining how to leverage your protection by purchasing index puts. It’s a leverage of protection against volatility.

Read those chapters again, because this exact scenario will repeat itself in January and again in April. Once we get closer to January expiration, the issue of hedging our position is going to arise yet again. This was a costly error.

But that cost has bought you something. At least you should view it that way. What it has bought you is a lesson in why in the future, you cannot afford to make that same mistake. We don’t always have market risk, but if you see Bullish Cross raise the issue, most likely it means there is an actual big risk.

So now the framework for anyone who is not hedged is basically the assumption of risk. It’s entirely up to you whether you want to assume that risk. There is a chance that Apple can crash and burn with the market. There’s a great chance that the market can put in a double bottom and rally. Apple could bottom on the iPhone event and snap all the way back to $405 a share.

If you hold the position, you assume the risk that the market can flush over the next few weeks. I wish there was a better way to deal with this. But the fact of the matter is, there really isn’t. Rolling over into November/December options is not a good idea either. Mostly because we know that Apple tends to sell-off after it reports its earnings. Thus, the only roll-over strategy their is right here is giving up on the October trade and moving that capital into January.

That’s the more conservative play. We may even have to do that despite the fact that we are hedged. If we don’t see a big slide in the markets, and Apple starts to underperform, then we’ll probably have to get out of October even though we are hedged.

Remember, this investment like any other investment has its risks. I know there’s a tendency for our members to think that we are somehow infallible but that everything we do works out. Unfortunately, that is not the case. Instead, what we offer is the best overall trade we can make which contemplates and address different risk levels.

I think this October spread was a very well packaged and well hedged position. If the market sells off significantly we even come out of the position with a gain. If the market and Apple rally, we come out with doubling our money.

But we will obviously be watching things very closely this week. You want to be focused on our directional framework and technicals as the week progresses. Because that will give you a good indication of how to deal with your October $380 – $400 spread.

74 Responses to The Apple Game-Plan for October

  1. Hey man. When you say “we” are working… Is there someone else there or is it just you banging this knowledge out?

  2. Dear Andy

    Great article. One request-When you recommend hedging if you can suggest a certain number of hedges based on the dollar sum at risk on Apple would be good. Every member would have different number of spreads at slightly different prices so if you suggest number of hedges based capital at risk it would be great.

    Thanks.

    • So we explained it by proportion which should do the same exact thing that you’re mentioning. Like in this model, we have hedged with approximately 7.7% of the October spread. $350,000 was allocated to the spread. $325,000 was used on the position and $25,000 was used on the hedge. You can scale that up or down right?

      If you had $32,500,000 invested in the spread, then you have a $2,500,000 hedge. It’s all scaleable.

  3. brilliant bring on the next chapters…

  4. Andy, you needed to write this article. Many of us, including me, didn’t follow you to the letter. I hedged at < .90, but not enough to protect my entire Oct spread so I will likely be taking a loss on it. Mea culpa.

    The pendulum seems to have swung to protecting against downside risk more than upside. What I've been reading over the weekend is, to me surprising at least, a near uniform consensus that we're going down on the spy to 110, if not 100 or lower. We'll be looking to your guidance on what this would do to aapl.

    I'm glad you are with us on this one. There is no one else I'd trust to follow in the most precarious times.

    • ” …a near uniform consensus ” in financial markets is a good sign that things may reverse, and pretty soon

      • I think that’s one of the few good signs, but I wouldn’t bet on it this time. Too much technical damage has been done. . . .hope I’m wrong.

  5. Andy thanks for everything. Just curious what odds would you put on aapl not closing above $400 or between $390-$400?

  6. One more thing Andy I came across this. It looks exactly what we just went through. Do you feel this is what will happen
    http://www.traderslog.com/throwbacks-and-pullbacks/

  7. Andy,

    What’s your latest thinking on whether we are getting one or two iPhones?

    Mac rumors suggests we are getting the iPhone 4s, but made no mention of the iPhone 5.

    Any chance we only get the 4s and no 5?

    Tom

    • Tom, Andy has addressed that question a few times in BC Live – you may want to go review a few days back. The market has likely priced in a single new iPhone, but even if two were released it would take a major surprise to matter, which a second iPhone is unlikely to be.

    • I think the market should be shocked if Apple only released a 4S spec bump, which would be bad for Oct OpEx. For every 4S only article, there’s a 5 article. AT&T received covers for a 4″ 5 — I would be pretty shocked if AT&T purchased cases on 100% speculation, so there’s something to that.

      This article seems to confirm two iphones — 4S might be a world phone focused on prepaid and China.
      http://www.tuaw.com/2011/10/01/iphone-5-appears-temporarily-on-cincinnati-bell-website/

      I used to be a so focus on Apple news announcements, and it’s still good fun, but Andy is showing us that if far less important that watching what the market is doing and how AAPL is behaving with the market. I’ve learned SO much in past couple of months I can’t believe it.

  8. OK I’ve been laying low …

    This article mentions “trust”. Well, trust is earned not asked for. Before that sounds negative, let me say the trust has been earned now. A few months back B.C. was too new and I was learning so much so quickly that my head was spinning. I wasn’t able to implicitly trust. I made some trading mistakes and I would have been better off just following closely. Even so, I have still walked away with a gain.

    Andy shouldn’t need to “bail out” any of us. This is an educational service. Any money you make or lose on trades is your own. Andy shouldn’t have to worry about that. Is anyone out there not getting their monthly educational money’s worth here? (crickets)

    Andy clearly outlined Oct risk from the beginning of the thesis. Oct is only 1 bet in a series. Andy has been on the mark so frequently that I wonder sometimes if Doc Emmett Brown gave him a stock almanac. So don’t waste any of your precious time catering to those who aren’t following. Keep the focus back to the future. Keep educating and we’ll follow.

    • For the pure educational purposes both devote followers and few greedy souls will benefit from Andy’s gratious offer to show the plan B.
      I’m guessing that while hedging with index options is off the table, the only remaining alternative is cash, which has to be raised by closing October spread now, before the damage is small. Than wait and see how things unfold. If AAPL tanks lower, buy a lower spread with the same yield potential or redeploy October cash into January.

    • Biff, what needs to be thought of too is that Andy is trying to build a business, and (like Apple) wants to over-deliver for his clients. I do agree with you though that we are all responsible for our actions and he may be better served with more sleep, but it’s his call to make. See you at the malt shop!

    • ok come on….If we can bail out big financial bankers, why not the little guys like Andy’s subscribers? :)

    • very,very well said ,,spot on

  9. Thanks Kevinj

  10. Excellent job, Andy.

  11. Andy you stated above that “there’s a fair chance that Apple does’t close above $400 at OpEx” yet on the 27th of sept you stated “I think it’s important to note that I think it’s becoming increasingly likely that Apple will be well above $400 by OpEx” can you pls advise why the change? and don’t u think that this 10% plus drop in apple(from 420plus,ok it was overbought by any stretch, but drop 10%!) has something to do with J PMorgan asia report(regardless of it being incorrect,rejected by Moskowitz etc) that report,right or wrong is the first time someone (with a high profile,JPM) comes out questioning apples growth, and more importantly on a new stream of revenue i.e the Ipad?,cause i really cant see any reason for this large drop as we all agree that apple isn’t following the s&p or the market in its decent (apple was up 10 on its way to 420 when the QQQ was down almost 50 points!)

    • There’s a lot going on. It’s the point of this article. I can’t just answer it in a comment. So there’s conflicting evidence. There’s good evidence for Apple closing above $400 and now there’s new evidence against. We’ll get into both. It’s an issue of market timing. The market could take a big bath between now and earnings. Apple outperformed two weeks ago and now it’s not outperforming anymore. We’ll get into it.

  12. Andy, In most cases, IMHO, the trust is there, no question about it. I for example, have hedged with the QQQ puts and am in the black versus ALL my AAPL spreads. But I think many of the questions come from curiosity and the need to learn and trying to be at the same level as you are. I know its impossible cause it takes a lot of time and real experience including making mistakes, but while we want to follow you, we are also impatient and want to know why you advise something and whats behind the curve before even taking the initial steps! Its just human nature and unfortunately only after we burn our fingers we internalize the negative experiences permanently. Please bear with us and thanks for being patient and for all your tremendous work.

  13. Andy,

    Thanks for ALL the great strategy, tactics, adjustments, comments, and open sharing. All given with a “no bullshit” chaser of straight talk.

    May the Force Be With You and Thanks!

    Peter

  14. With Amazon commoditizing tablets, and probably getting into 10″ tablets and phones next year, AAPL margin compression case seems plausible, which would imply earnings compression , resulting in price target downward revisions.
    Any comments anyone?
    See this:
    http://seekingalpha.com/article/297084-will-tablet-makers-experience-margin-compression?source=yahoo

    • That guy is an imbecile. Why even link to such idiocy?

    • Not knowing the guy I can’t comment on his imbecility. But his logic doesn’t seem so stupid.

      • That article is enough to form an opinion. If he is not a complete moron, then he’s just full of shit. Probably both. See the George Carlin link I posted above. :-)

    • Why are you quoting that clown?

    • I think it is reasonable to assume that Apple will take a hit on margins someday. But as investors we are looking at the next quarter or two, perhaps the next year or two, and out to that horizon I don’t see any evidence of margin compression. I might be forced to reconsider come earnings time, but I rather doubt it. Still, certainly worth keeping an eye on.

      • Apple is not the type of company that competes on margins. They sell premium products and people pay more for the type of products they make because they’re better. There’s no other company around which will be able to challenge Apple at their own game for years to come. Apple itself needed many years of perfect execution of a brilliant strategy to arrive where they are today. I would love to be proven wrong because that would mean more innovation and better products for everyone to enjoy.

        • All good points, and we all know what a great story the company is. Still, any number of things could weigh on margins at some point. As a consumer I don’t really care; as a long-term investor I trust management to keep the company humming. As a short-term investor, however, and nearly all of us reading this article are, we have to worry not just about Apple’s performance in the market but the perception of its performance. Analysts always seem to be predicting gloom and doom for Apple over margins, and the market will punish Apple should they ever fail to deliver on that score. I don’t lose any sleep over it, but I do keep an eye on it.

    • Everyone cares (read: worries) about Kindle Fire threatening to iPad, should read and only read this article on asymco.com:
      http://www.asymco.com/2011/09/30/the-case-against-the-kindle-as-a-low-end-tablet-disruption/

      I could find more articles about this, but it doesn’t matter since Kindle Fire doesn’t matter to iPad. It just kill all other Android tablet for iPad (see the garage sell of RIM playbook and HTC these two days?). Thank you, Amazon.

      • I agree weipeng. The tablet prices you see today are garage/fire sales of companies that probably will soon be out of the tablet business. HP. RIMM. HTC come to mind. And Amazon will make it difficult for anybody else to compete at the low end. Yet the Kindle Fire does not really compete with Ipad. It should help drive out the cheaper tablets leaving only the two companies with the full eco-system to compete. AAPL and AMZN. I wonder if there is any truth to the rumor that AMZN might buy another operating system.

    • Henry 3 Dogg

      This same chap was predicting the crash of Apple to $100 last week. The main hinge of his argument seemed to be.

      “Yes, I know that Apple has 10% of its enterprise value in cash. I know the firm has no debt. But I also know that the company spends like crazy on R&D and sell-through is everything to a firm that is playing in this space. The problem with these sorts of firms is that when you’re running on afterburners it’s nearly impossible to pull back without losing control and crashing…”

      In other words, he doesn’t even check his basic facts. To say that Apple spends like crazy on R&D is not simply a matter of definition. It’s out and out ignorance of the fundamentals of the company.

  15. Since joining I have followed the tweets closely. The hedge was a great move. To me, selling the Oct spread right away may be premature. AAPL is at its 50ma. The last 3-4 times that was a buying opportunity. Should be interesting to see Andy’s strategy.
    One question: In choosing the Jan12 spread, we took the 400/420, nicely priced, leaving some $$ to hedge. We could have taken the 390/410 for under $10. Wouldn’t that have been a hedge in itself since it has a better chance of succeeding? 1,000 pennies ($420-$410) is not a bad hedge when at opex every penny counts. I’d rather have taken a few extra bucks to hedge that if necessary than using the money saved from a higher spread for the same purpose.

  16. I find that article worthless, and a problem of SA in general (98% worthless). It’s 5 paragraphs of oversimplified, naive speculation which probably comes from running businesses. It reminds me of statements like: Android is going to destroy iOS just like Windows did to the Mac.
    - The author’s resume is in networking/ISP, a very diff market. His current co. looks like a financial forum/BB. The brevity and hyperbole of the article suggests a “looking-for-pageviews” mentality.
    - In my mind, my 8yo has as much credibility/content on the market. He has said (no kidding): “is there anyone who makes a tablet that isn’t a copy of the iPad? The Galaxy Tab, that Motorola thing, they’re all copies.”
    - The original Kindle and the iPad are not in the same market — but google back to the Kindle and iPad launches and you’ll find similar crap spewed by pundits
    - The Fire and the iPad are also likely not in the same market — Fire is closer to an eReader than a tablet. Most folks think Nook and other Android makers are in trouble.
    - Kindle Fire is not even shipping. After they _publish_ financials about Kindle, will be the time to pay attention.
    - Unlikely AMZN gets into phones, too complicated, no value-add, non-optimal eReading exp, non-optimal buying experience, non-optimal media-consumption experience
    - Netbooks, PCs have not caused margin compression for MacBooks. AAPL owns the most profits by far in the PC market
    - The same holds true for tablets b/c that market is the iPad market
    - After AAPL margins compress measurably, and iPad revenues/earnings slow measurably for 2 qtrs in a row, then it’s worth having this discussion

    • I meant “which probably comes from running businesses in a low-level market like networking.”

      Can I ask the subscriber base to keep comments to the article posted? Other topics, wait for the forums to come up.

    • Agreed. The quality of SA contributors has fallen off a cliff this year (e.g. the above-linked ‘article’), and the general tenor of the comments sections continues to raise the bar on crazy (look at any RIM-related article to see how juvenile the crowd there has become).

      Seeking Alpha proves the old adage about free investment advice being worth every penny you pay for it.

  17. Re margin compression thread:
    My guess is apple will not cede the “entry level” market to amzn. Too big a market to ignore and gives amzn an unnecessary foot in the door.
    They will continue with their policy of selling older models really cheap, ala 3Gs at $99, which means that they will probably soon sell iPad1 at $299 , wifi only, 8Gig, which will render amzn’s 7″ Fire dead on arrival.

  18. Following Andy’s plan, the QQQ puts has me in the black for the Oct OpEx. In Andy I trust.

  19. Andy,
    Curious as to ur opinion if this is the start of the 3rd leg down (to 1040) or if we are still in the 1120-1200 trading range? How many times can 1120 hold typically?

  20. Andy, when explaining how to handle the unhedged 380-400, I hope you can throw in a few principles about how to approach unhedged positions in general, at least as concern the sort of conditions Apple investors are facing now. While I don’t expect a direct answer, I’m sitting on some 365-375 options from way back that suddenly don’t look as solid as they did only Thursday. Here’s hoping that you throw in enough on the educational side such that we can now better think through our own problems now and in opex’s to come.

    • I’m in some 350-370′s that I’m starting to wonder if I should roll lower – relatively new to spreads

  21. Seating at apple store in Miami , FL . getting my mac serviced , replacing my iPhone after dropping it off in the water …. and looking at this crowd 24/7 I Can not imagine How apple can not trade at $400 at earnings !!!!!!!!!!!!!!!!!!!! I hope the market can give us a break this time .

  22. Considering the decision to give Greece their next bailout will be made on 10/13 (which the mkt is pricing in a yes) & their next payout being in Dec (which I’ve been reading is most likely the time for default – granted still a guess), I’m curious if we haven’t taken either the Jan & April positions should we wait? Take 1/2, less?
    I’m hoping for opinions/discussion on above. What does everyone think?
    From what I’ve read, a control default will still impact the mkt but to a far lesser degree.

  23. Forget Apple’s PE ratio. Horace Dediu has conclusively proven that its PE is no longer relevant, that the market values Apple based on the strength of its balance sheet. The multiple he’s discovered is roughly 5x cash.

    here’s the most recent update to his analysis:
    http://www.asymco.com/2011/09/26/when-will-apples-share-price-reach-500/

    With a current hoard of $76b, and due to report at least last quarter’s cash (ca. $12b), Apple should be at close to $90b after October’s earnings. Thus, the target price for next quarter is +/- $450.

    Like the rest of us, I’ll wait for Andy’s analysis of why he think the market risk will pull Apple down, but Horace’s observations about how the Street values Apple is tough to ignore.

    • Apple’s P/E ratio is important. Cash is a function of how the stock is valued on a P/E basis. For example, suppose the stock has $300 billion in cash. That cash level might proscribe a particular low end P/E ratio for the stock. For example, it might suggest that the stock will bottom out near a 10 P/E level for the long-term.

      They both work together.

      • isn’t a HUGE cash balance a negative for the stock and investors?
        A business is evaluated how well it utilizes its cash. But apple is a special case – none of its business follows the norm and it has redefined the rules. That’s true in this case.

        But to say that the price of the stock is a function of Balance Sheet alone is a very limiting view.

        P/E ratio is very important but one has to look at everything.

        Apple operates in a very competitive environment – technology right now changes very fast – what’s hot today is outdated in a year. Apple’s market cap also works against the price. I think these are primary reason why it is cheaper than what it should been…

        • Even with the crazy amounts of cash, AAPL’s recent return on capital is in the high 20%’s and has been in the 20′s for many years now. As a shareholder, that tells me AAPL is investing whatever earnings they are retaining wisely. Could you or I get returns in the high 20%’s on tens of billions of assets? If Warren Buffett can’t, thats partially why he’s returning money to shareholders through buybacks now, I doubt I could.

          It would be nice to see a buyback or dividend or something, but its not going to make ~$250B flow into the stock to get it to price that might be considered fair value. Finding ~$250B of outside capital to put into the stock is the problem, not the $70B that could reasonably flow out of the business. The good news is that as long as that cash sits in the business, we have a floor that gives the stock risk/reward profile easy enough to figure out and capitalize off of. If Apple can keep growing like it has, the cash is kind of a blessing.

        • fyi, Horace noted the difference between correlation and causality

  24. One would think that there is still a significant undercurrent of interest in AAPL given its recent significant out-performace and detachment from the market from 9/13-9/21.

    • On the detachment question, I overlaid the one month and three month spy charts over apple’s (I’d attach them if I knew how). As far as I can tell, there were significant detachments after earnings in July (huge one) and from Sept. 15-20, but in between and since Sept. 20, the charts look similar.

  25. Andy, excellent article.
    Experience is very hard to past to others. As they say: Every new generation has to find out that the stove is hot.

  26. Andy,

    Apple mgmt (CFO) said this on last conf call:

    As we announced at WWDC, we have a lot going on in the fall with the introduction of iOS 5 and iCloud. We also have a future product transition that we’re not going to talk about today and these things will impact our September quarter. We remain very confident in our business, our new product pipeline and our momentum.

    Any idea what the product transition is? The CFO implied that the transition might be a headwind in my view.

    • The obvious guess would be iPhone. Much less likely would be an iPad refresh, but I don’t see that happening. The iPods are also due, but as Andy points out that’s only 5% of revenue these days. (That is amazing when one considers how exciting the iPod was in the past.)

  27. NOT looking pretty..

    http://www.arabianmoney.net/us-dollar/2011/10/03/heading-down-below-the-march-2009-stock-market-lows/

    And I’m one of those fools who only listened to PART of Andy’s suggestions these past few weeks–the ones about the possibility of the market going up. NOT the ones about the market going down. I’m about 90% in. I’M Nervous.

  28. I wanted to trade in two parts or three. So I bought 50% of the hedge and then I got busy and completely forgot. I thought I could still pick it but never got a good opportunity. So I am 50% hedged right now.

    Andy, if i understand correctly, you are saying those who have not hedged to sell and roll it to a Jan spread; If this understanding is correct then, a request, would you suggest a time when to do it?

    • No. I’m saying for those who are not hedge they need to make their own decision on whether they want to continue to hold a position that has unlimited downside risk.

      Read that whole last section again. There is evidence suggesting that Apple could very easily close above $400 at expiration and there is evidence that Apple can also fall apart with the market taking a 2nd leg down now.

      It’s really up to the unhedged investor whether they want to assume that risk. Some may want to assume that risk, and others might want to sell that position and roll over into a January spread. I’m not going to spend hours guiding two different groups of people through this trade.

      Then we have groups where people took a partial hedge or decided they wanted to leg in or decided they wanted to do xyz. Can you see how it would take me 1,742,421 hours a day to run all of these different strategies for different positions and different people?

      Like the idea here is to run 1 model that people either follow or they don’t follow. The models aren’t even really necessary for a lot of someone. Some people run their own completely strategies and use bullish cross to determine market direction and/0r for the fundamentals.

      If you look at our market and Apple direction calls over the past few months, we’ve been pretty damn flawless. So there are a lot of people who just follow the directional aspect of Bullish Cross.

      Yet, at the same time, some people want some modeling as well. So I do that. But I can’t run 700 variations of a model. I can really just run 1 model for each strategy and then people can decide to derivate as they see fit. So when you say…

      “If this understanding is correct then, a request, would you suggest a time when to do it?” I can’t because each person is going to want to do things differently. The point I made at the end is this. I’m going to update the directional outlook i.e. give a likelihood of Apple/market direction. You can use that to make a determination of when to make that trade.

      That request that you’re asking for means I have to give that timing issue for like 500 people depending on the varying risk tolerance.

      • Andy this article was probably one of your best. You have no idea how much I love this $&#T that you model & articulate for us. Learn VOLUMES from you. Smartest author/technician I know on market analysis. And I $STUDY a lot.

        ps – you used the word “derivate” at least 5 times in the body of this work → it’s “deviate!” not “derivate”

  29. Andy, appreciate your hardwork writing this article. FWIW, I have followed your advice on the 10-bagger strategy (just wanted you to know that some of us are listening, cuz at times you sound so frustrated that it seems liked no one followed you), and am GRATEFUL for your step-by-step advice on the way in, and now, the step-by-step outline of the various exit strategies depending on how things play out. Hope you get enough sleep and stay healthy ;-)

  30. as someone who sits with the oct 380-400 unhedged, what’s the harm in taking the QQQ Oct $50 Put at $1.37 now (hypothetically of course, as the market’s closed)
    If the market tanks then there’d be upside to that. If somehow that doesnt happen then it’s a wash, right?

    • As he explained, you’re buying puts at historically expensive times when the VIS is sitting at 40. So puts are expensive right here + you know assume even more risk if the market rallies and aapl underperforms (unlikely scenario) but still possible.

      As Andy says here:

      “You can’t really buy protection at this point because it will be very expensive to do so. The $54.00 puts on the QQQ were at $0.99. Now they’re at $3.00. Best case scenario, they triple in value to $9.00 if the QQQ absolutely crashes. But there is a lot of risk that this doesn’t happen. We could see the QQQ rally and Apple tank. That’s very possible. That’s why you can’t really buy protection when the $VIX is sitting here above 40. You are just making the situation worse for yourself.”

    • I would just do the math on it. You’ll find that you’re just basically risking more capital by buying the protection for very little return.

      • I know that what you’re saying must make sense. But it also seems like it doesnt make sense

  31. this one was hands down favorite of them all →

    “Now here’s the silver lining. I think it’s actually pretty good silver lining actually. I’m good what I do now because I’ve had my share of huge gains and huge losses. I’ve taken my beatings and now I’m at a point where I’ve crossed a certain threshold where the market has essentially become my bitch. I have pretty high level of confidence in my abilities now, and that confidence helps me see through all of the nonsense which in turn helps me make very sound decisions. ” – A. Zaky

  32. Andy, when you say the following, what chart timeframe are you referring to make the BB decision. Here’s what you said “If there is anytime where I think a swing trade in your entire Apple position is warranted it’s whenever the stock flies above its upper bollinger band. ”

    Thanks.

  33. Excellent article. I’m hedged and (pretty) comfortable. Thanks for your hard work and analysis.