Apple Isn't a Tree, It's a Hedge

TheStreet.com

NEW YORK (TheStreet) -- For many Apple investors, the stock is only a couple of down days before it's time to wash their hands of it. It's easy to understand, when the news is full of reasons why you should sell and the shares are trading near 52-week lows.

Typically, when a stock is trading near 52-week lows, it's a sell. After all, there's a reason why investors are bailing out, and the market usually gets it right. But sometimes the market is wrong, and it isn't changes in the fundamental business model that's driving share price; it's emotion and fear.

You're making a substantial mistake if you underestimate the role emotion play in pricing securities. Emotion is especially influential during relatively short time periods. We see it every day in the market. A stock can gap higher at the open, fall below the previous day's low, and then spring back to close at a new high.

Obviously the underlying company didn't change in value in a single day. In all likelihood, the company produced about the same amount of widgets as it made the day before and will make the next day. The force moving the share price is emotion, and while it's easy to visualize its impact during a single day, investors should know that the same applies over the course of days and weeks.

You have to view stocks on a monthly chart to (almost) remove emotion. Change your chart time setting to monthly, and look at any stock. Next, look at the quarterly earnings report and what you will find are stocks that have charts matching the fundamentals.

For example, take a look at Radio Shack and Pitney Bowes , Both have falling revenue and earnings. The monthly charts take away most of the noise and leave you with a true sense of direction.

Now try the same with Apple .

Apple's monthly chart has rising 60-, 90-, and 200-period moving averages. With a price near $400, the stock is also trading well above the moving average. What this tells me is that money continues to flow into Apple, but emotion during 2012 drove it too far too fast. In other words, once you remove most of the emotional drivers and ignore everything other than the core (sorry, bad pun), what you're left with is a rising stock with solid fundamentals.

That's all well and good, but it doesn't invalidate the Wall Street adage, "The market can remain irrational longer than you can stay solvent" (no, it wasn't Keynes who first said it). For those that would prefer to wait it out but can't risk further price declines, or if you're ready to sell for whatever reason but don't want to time your exit, I have a solution to consider:

At $397.55 (current price at writing), an Apple investor can sell September $415 calls against the shares owned for about $13. By hedging with call options instead of selling your shares today, you give yourself another $13 of cushion during the summer months to wait and see what the next earnings release brings and give the market sentiment a chance to change.

You also collect on the next August dividend payment. Based on the last $3.05 distribution, you then have $16 that Apple needs to fall before breaking even on this strategy. On the other hand, if we are near the bottom and shares are trading above $415 on expiration day, you can simply buy back the options at the going price. With your gains from the stock appreciation, dividend, and initial option premium, you're fully covered. In fact, if Apple is above $415 on option expiration day, you will gain about $30 more than if you had liquidated today.

Using covered calls is an excellent strategy to lower your risk and portfolio volatility for your long-term investments. For another of my takes on Apple, read whyApple Could Become Your Next Bank.

At the time of publication, the author had no position in any stock mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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