Larry Berman

Berman's Call

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The amount of options bought for expiry this week is some of the big tech names like Apple (AAPLUW) and Tesla (TSLA:UW) are huge.

When an option is bought, the market maker typically hedges by buying the underlying stock. When the option expires, that hedge gets sold or the stock gets called away if it’s in the money. Either way, the buying power evaporates. Market makers will not want to pay out on these and we should see some additional downside selling towards the end of the week to defend these positions. The majority of these speculative options are at current levels or higher.

Back in 2000 when the tech bubble unwound, it was not a straight line down. This one will not be either. And the fact that while valuations are extreme, these are real companies with mature earnings and cash flows unlike expectations 20 years ago, which makes valuation a bit easier today. Remember that 20 years ago, there was no iPhone. Over the next week, excitement around Apple’s new 5G iPhone launch (Sept. 15) and Tesla’s battery day (Sept. 22) will be reasons for speculators to speculate.

The options markets give us some insight into market risk being priced in. By Friday, the breakeven (based on Friday’s US$112 close) on an at-the-money US$112.50 straddle is about US$105-$120 this week. Investors should not be too surprised to see this range tested. What seems most interesting with AAPL is that earnings expectations have been relatively flat for the past few years (red line) while the price has tripled since earnings expectations peaked in 2018.

Betting against APPL has been a bad bet – so we are not saying sell it or don’t buy the dip. What we are suggesting is where that next best opportunity might be and the answer is lower, much lower. Technically, the pre-COVID highs around US$80 would be a minimum and at that point, it would still be twice as expensive as it has been for the past decade. Sure, let’s get excited about 5G and new technology drivers, but at what price?

The Street always has a bullish story to tell. Technically, the 200-day average is rising in the US$83 area and retracement targets are between US$85-95 range. Investors can sell an 80 put for September 2021 and earn about US$4.50 (almost four per cent based on current value). Not bad for conservative investors looking to buy a dip. I’m all for buying growth at a reasonable price. But prices just are not reasonable and earnings growth for AAPL does not warrant the current multiple people are paying for it.

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