Apple (AAPL) continues to be the most talked-about stock, not because shares are eclipsing new highs but because of the 30% drop that shares have experienced in the past several months. The decline has been so rapid that some value-seeking investors are buying or making a long case for owning the stock.
The most recent headline pertains to the hedge-fund manager David Einhorn suggesting that Apple issue a high-yield preferred stock security that would mathematically serve to increase the value of the common stock. Einhorn's hedge fund, Greenlight Capital, has been an Apple shareholder for a few years now.
The value investing adage is that price is what you pay, but value is what you get. Apple shares are trading for $480 a share. With each share comes over $100 per share in cash and investments. Despite concerns that Apple's growth rate and margins are facing pressure, nearly 5 billion people in the world are still without smartphones. If Apple captures even 20% of that market, that's a lot more iPhones to sell. And over time, I believe that tablet computing, specifically the iPad, will continue to juice sales and profits.
More so, Apple requires no excess cash to run its business. That means that Apple could theoretically pay out a special dividend of $50 or $100 per share and not have to worry for a second about its cash needs. This is, of course, why Einhorn is going front and center with his idea of a high-yield preferred stock issuance.
So Apple shares have a lot of interesting upside optionalities that are attracting more and more value-seeking investors today. The market, in my view, appears to be getting inflated. At the same time, one of biggest cash-generating companies has seen shares fall 30%. Dare I say that if the market were to experience a healthy pullback, Apple would outperform? It's a lot less risky to own Apple at $480 than at $700.
But why pay $480 for the common shares when you can get the options for free? No, not free in the common sense of the word, but in the financial sense. The Apple January 2014 $300 calls can be bought for around $182, or a time premium of $2, less than 40 basis points of Apple's underlying stock price -- basically nothing in option pricing. So instead of coughing up $480 a share, you can get the same exposure and virtually the identical risk for $182, or 38% of the stock price. If Apple shares were to drop to $300 a share, you would lose the same dollar amount as if you had bought the common at $480.
As a minuscule bonus, if the market gets Apple fever again and shares become more volatile and advance, you may pick up a few bonus percentage points, as volatility theoretically would increase the price of an option. For an additional 1% or so, you can draw out your bet to January 2015, not a bad idea at all, given the quality of Apple as a business and as a cash-flow generator.
Nothing prevents Apple shares from falling further, but since it has such a strong balance sheet and business franchise, many investors who have tons of cash and who are sitting on the sidelines get an instant opportunity to put that cash to work. With so many favorable upside options, it's not a bad idea to bet on Apple via an option.