Activists Take Aim at Apple (Nasdaq: AAPL): A Quick Profit Opportunity

by David Eller, Investment U Research
Thursday, February 7, 2013

Two strange things have occurred in the last two days that may bring a sigh of relief to Apple (Nasdaq: AAPL) shareholders:

• On Wednesday, Bill Miller, the investing rock star from Legg Mason (NYSE: LM) commented to the Financial Times (on the record) that if Apple began offering a dividend, it could appreciate as much as 50%.

• Then, David Einhorn from Greenlight Capital approached the SEC to request it step in and force the company to make a change to one of its proposals that would allow the board to issue preferred stock as a dividend to existing shareholders.

Activist investors are like modern day pirates. They approach companies that have high-quality assets, hoist a black flag and let the management know that if they aren’t accommodating, they will be removed as captains of the ship.

These activists typically own a stake of 5% or more in a certain company. They’re required to file a 13D document with the SEC, outlining the demands they’re making from management.

Those demands often include…

• The sale of the company or certain assets.
• Instituting a share buyback or special dividend.
• Firing the CEO or replacing members on the board of directors.
• Reining in executive compensation.

These demands all have one goal in mind: to unlock shareholder value – i.e. make the share price rise.

The quip by Miller is interesting, but  Einhorn has a following of investors who like to ride his coattails.  They did this successfully in Chipotle Mexican Grill (NYSE: CMG) and Herbalife (NYSE: HLF) very recently.

The Apple annual shareholders meeting is scheduled for February 27 and with this new turn of events, it’s difficult to see what will take the company to a new low before investors argue their case for a cash distribution. Here’s a couple of ways I see that speculators could profit from this…

How to Play it with Options

A conservative way to capitalize on this would be to sell a put spread near Apple’s recent low of $440.

Here’s how such a trade would work. (NOTE: These options values are subject to change rapidly, so just use these numbers as an example of the strategy.)

You sell a $440 put and receive $3.50 per share for a total of $350.  To hedge your downside in the event of a catastrophe, you buy a $410 put for $0.69 or $69 for a full contract.  The net profit is $281.  Your break-even point would be $437.19 which is $20 below the current price.

It’s important to buy the $410 hedge for two reasons.

• To protect against an act of God or a flash crash.

• Selling one $440 put would tie up $44,000 in buying power.  Purchasing the offsetting $410 contract would reduce the maximum loss and buying power commitment of this to $3,000-281 or $2,719.

If the share price falls below $440, you risk having the stock put into your account so you have to either want to own 100 shares at a price of $437.19 or be willing to close out of the spread position if it is put to you. The idea behind taking this type of position is you believe that the stock will remain range-bound until the shareholder meeting.

Obviously you can adjust the options you’ll use based on how much risk you’d like to take on. But a trade like this is a quick way to earn some cash in the next two weeks.

Good Investing,

David Eller

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