Is The Options Market Betting Against Apple's Recent Rally?

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At times, it's useful to take a peek into the options market to see what options traders are pricing in -- or not pricing in.

Ahead of Apple (NASDAQ: AAPL  ) earnings, the market was pricing in a $35 move in either direction, judging by the price of a near-term straddle. That volatility play would have proved profitable, since shares plunged an incredible $57 after the iPhone seller didn't sell as many iPhones as investors were hoping for.

Over the past week, Apple rallied amid talk that the company should increase its dividend. It can certainly afford to and investors are demanding that Apple return some of that cash since it has well more than what it needs for operations. As it turns out, the options market is not pricing in any type of dividend increase within the next year. Is it right to bet against Apple's recent rally?

Some numbers games
A synthetic stock position created with options typically involves going long a call while shorting a put, usually with the same strike price and expiration. A position of this kind will tend to replicate the performance of the underlying asset. The goal is to get the combined delta of the options as close to 1 as possible, which would mean that a $1 change in the underlying stock would translate into approximately a $1 change in the total combined value of the options.

Options traders at Susquehanna Investment Group have taken note of what the market is saying based on the current price of a synthetic long. Specifically, they are tracking the price of a synthetic long created out of a call and put that both have a $500 strike price and expire in January 2014.

A week ago, when Apple closed at $453.62, this combo trade would have been worth $54.20 (buy the call for $26.73 and sell the put for $80.93). They estimate that this was pricing in an expectation of approximately $10.22 in dividends over the following year, which is pretty close to the $10.60 Apple currently pays annually. These amounts won't line up directly because of a number of other pricing factors, including interest-rate assumptions.

Within the next week, Apple went ex-dividend for the current quarter's $2.65-per-share payment, which means that the amount of dividends that the options market is pricing in should decrease by approximately that same amount, bringing the implied total to roughly $7.57. Instead, the combo was worth $37.55 (buy the call for $35.40 and sell the put for $72.95), implying a dividend stream over the next three quarters of $8.13.

Put it all together
There are a large number of variables and assumptions to consider with all of these pricing factors, so these figures shouldn't be construed as exact estimates. However, they do serve as a proxy for what types of expectations the options market is pricing in. The point is that the options market is pricing in a small probability that Apple will increase its dividend by a small amount over the next year or so.

However, if you consider the amount of unrest that is gathering within Apple's investor base, as partly evidenced by its 40% pullback and enormous cash position, it seems that some type of meaningful dividend increase is likely to be in the cards. In Apple's official statement from earlier this week, it specifically said, "Apple's management team and Board of Directors have been in active discussions about returning additional cash to shareholders." [Emphasis added.]

Apple's statement implied that thinks it needs only about $100 billion in cash for operations, meaning it has plenty left over. The company generated $23.4 billion in operating cash flow last quarter alone, and its total cash balance increased by $15.9 billion sequentially. At the rate that Apple is generating cash relative to what it says it "needs," within the context of disgruntled investors, I'd say the chances of a substantial dividend increase before year's end is highly likely.

Otherwise its cash position will start to approach $200 billion, and if you thought investors were irritated now, how do you think they'd feel then? The increasing investor agitation is commensurate with Apple's excess cash, and no company likes agitated shareholders. The options market is underpricing the likelihood of an Apple dividend increase.

There's no doubt that Apple is at the center of technology's largest revolution ever and that longtime shareholders have been handsomely rewarded, with more than 1,000% gains. However, there is a debate raging as to whether Apple remains a buy. The Motley Fool's senior technology analyst and managing bureau chief, Eric Bleeker, is prepared to fill you in on both reasons to buy and reasons to sell Apple and what opportunities are left for the company (and, more importantly, your portfolio) going forward. To get instant access to his latest thinking on Apple, simply click here now.

Read/Post Comments (3) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 10, 2013, at 9:14 AM, EquityBull wrote:

    Apple said the exact same thing on their last conference call as well as prior calls verbatim that they said in this statement. They are always considering this but they never do anything

  • Report this Comment On February 10, 2013, at 10:08 AM, sammycooool wrote:

    Apple makes for a nice short, its rallies on dumb news, you short it, easy money with Apple.

  • Report this Comment On February 10, 2013, at 12:19 PM, mjrkong wrote:

    I think the co. is in a state of shock at the staggering rise in its cash position. Hard to believe it was a "mere" 10 bill less than 7 years ago! What do you do when you win a 137 billion dollar lottery? Tough call. And is probably one of the reasons they hired XRX's CFO Luca Maestri to serve as their new controller (March 1).

    Hopefully, Apple will take a measured approach to any cash distributions, perhaps a dividend increase of 9-11% increase per yr over the next 5-7 years. That would push the payout to $20 by 2020. The co. would be able to add cash to the bank account while satisfying "value" investors.

    On the cash side, yoy growth last 5 yrs has been an unreal 51%. Over the last 10, 41%. If Apple were to maintain that 40% growth (unlikely, but who knows) cash would top 1 trillion in 2020. Yes, 1 trillion. On the down side, even if Apple's sees a 50% decline in earnings over the next 7 years it could still generate cash of 200 billion, pushing it to the $335 billion level (while maintaining the 10.60 div).

    Plenty of options here for Apple and its 137 billion dollars, and if they stay smart, all good ones.

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