This Apple Strategy Could Beat the Company's Stock and Bonds

With more than $144 billion in cash and short-term securities on its balance sheet, Apple (AAPL) should have no problem paying back the $17 billion the company decided to borrow in the bond market.

Part of the proceeds from the bond will be used to pay an annual dividend of $12.20 a year. At that rate, the stock yields less than 2.7%. This is well above the interest rate on the 10-year bond that Apple sold, which will only pay investors 2.42%. Long-term investors could also buy Apple's 30-year bond for a 3.88% yield.

Thirty-year bonds carry an inflation risk. Higher inflation usually pushes interest rates up, and if interest rates rise, bond prices fall. Although the income should be safe given Apple's financial strength, investors could lose more than 17% of their principal if interest rates rise 1%. That loss could be more than seven years of income payments. No one knows what interest rates will do in the next 30 years, so many investors will prefer to avoid the risk of loss in 30-year bonds.

Inflation risk is unavoidable in bonds. Investors buying the 10-year bonds are facing a possible loss of about 8% of their principal if rates rise 1%. This loss would be more than three years' worth of income.

Given the risks in bonds, the stock could be more appealing to income investors. AAPL has been beaten down and is now trading slightly over 10 times next year's expected earnings. Analysts expect earnings growth of more than 20% per year for the next five years. If that target is realized, AAPL could be among the most undervalued stocks in the stock market.

The risks in buying a stock include the possibility that the stock might fall if the company disappoints investors or we head into a bear market. AAPL is more than 30% below its 52-week high even through the stock market is up over that time, which demonstrates that the stock carries a great deal of risk in both bull and bear markets.

Investors looking to buy AAPL should consider waiting for a pullback and selling put options so they can be paid while waiting for a lower price. When you sell a put, you agree to buy a stock at a predetermined price (known as the "strike price") until the option expires.

AAPL is trading at about $460 as I write this. Rather than buying now, I would sell a put expiring in June with a strike price of $420 for about $4.15. If AAPL is below $420 when the option expires in June, I would get AAPL for a cost of about $415.85 (the $420 exercise price less the approximately $4.15 received when selling the put).

Mini-options are now available in AAPL and cover 10 shares of stock. That means this trade could be done with $4,200 ($420 for 10 shares) rather than the $42,000 needed to trade a full-sized option contract covering 100 shares. The $4,200 could be held in cash in a brokerage account to buy the shares if the stock falls.

With the mini-contract, it is possible to build a position in AAPL over time, selling a new put every month or so and acquiring a position on pullbacks.

Income from a mini-contract would total $41.50 in this example, $4.15 per share times the 10 shares the contract covers.

For investors looking to buy AAPL, I would recommend selling puts about 10% below the market price whenever an option expires. If this strategy could be repeated six times a year, a trader would make about $250 a year (selling options for $4.15 on 10 shares). This would generate income of 6% if the investor set aside $4,200 in cash to buy the stock if it falls.

If AAPL falls below the options strike price, you would buy the stock at a price you are comfortable with and have the opportunity to sell covered calls on the shares you buy. With covered calls you could increase your income and make two or three times the dividend yield of 2.7%.

For AAPL, it looks like an options selling strategy could beat the bond or stock.

Action to Take: Look at the mini-options contracts on AAPL if you are interested in owning the stock. Sell puts below the current market price, which will allow you to buy on a pullback.

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