Lessons From Apple Crash

I won't go into models, forecasts, P/E ratios, DCF analysis etc. I'm sure there will be enough gurus doing just that. Most of this mumbo jumbo stuff is useless anyway - the markets will do what they have to do and will usually laugh at your analysis. Instead, I would like to offer some analysis how you could see the warning signs and what are the lessons from the American darling's crash.

Warning signs

When the stock has risen to $705, you could find plenty of warning signs. For example:

• Apple's value was more than 4% of the U.S. GDP.
• Options Implied Volatility jumped from 19% to 41% in a matter of few weeks with no significant news.
• You could make almost 50% in one week trading a delta neutral butterfly spread. Those returns are possible only with highly speculative stocks.
• Pretty much everyone was bullish on Apple. If everyone is bullish and already has purchased the stock, who is left to support further stock increase?
• The market was pricing the good news only and ignoring all the bad news.
• According to Forbes, some of Apple's insiders dump the stock.
• The positive sentiment reached extreme levels.

The Forbes article is especially interesting. The columnist argues that:

"Apple cultists may want to take notice that the top brass of Apple clearly does not believe that Apple stock going to $1000 is a sure thing. Blind faith is the hallmark of cultists. "

It also quotes an email from an Apple's cultist:

"You are wasting your time here……. Other analysts on AAPL are all silly? You are smarter? A nuclear physicist, so what? Apple will be above $1000 soon, no matter what you said……. You took profit at $360 and $525, shame on you."

Please note the definitiveness of Apple going to $1000 in the above excerpt.

Some people argued that the stock will get more support from dividend funds that were restricted to own it till now. I personally doubted it then and I doubt it now. The stock often moves up and down more than the entire year's dividend in just a few minutes. Most of the dividend funds don't want to own that kind of volatility.

History lessons

Unfortunately, in most cases of parabolic moves, those who join the party late buy the shares of those informed traders and investors who have already made significant gains and are ready to move to the next target. When they decide to sell part of their remaining portfolio, then the late comers, who are usually weak hands, panic and try to sell at break-even or just below that.

The recent crash also shows the dangers of over-concentrated portfolio. Many people went "all in" with Apple thinking that the stock will just continue going up $100 month after month. Obviously they were proven wrong. No stock deserves more than 20-30% of your portfolio maximum, and AAPL is no different.

Market history is filled with moves that defy logic as the charts "go parabolic." Those moves usually have 3 things in common:

• They go further than one would expect.
• They never last.
• They usually end really, really badly.

What now?

AAPL price action simply proves that there is no such thing "cannot go any lower". Is the stock cheap? Yes, some would say ridiculously cheap. But it was cheap at $500 too. Would I buy it now? The answer is no. I learned the hard way not to invest in stocks without some kind of hedge, no matter how cheap they seem. Personally, I'm implying non-directional options strategies that are designed to make money in every market. Since joining Seeking Alpha four months ago, I shared quite a few Apple trades with my readers. Here are some of them:

• The Bull Credit spread from December 13, 2011 produced a 42% gain in 6 weeks.
• The Iron Condor from January 10, 2012 produced a 28% gain in 2 weeks.
• The Long Butterfly from March 19, 2012 produced a 35% gain in three days.

Since Seeking Alpha discontinued the Options section, I cannot write options articles anymore. However, I still share the trades with my members - my last AAPL trade was a calendar spread just a month ago which made 25% in two weeks (the stock was down 5% during that time).