This Apple Trade Could Keep the Fiscal Cliff Blues Away

Bruce Frey III, InvestorsObserver

The typical year-end tax strategy involves checking your portfolio for unrealized losses you can use to offset realized gains. This, however, is not a typical year. With the fiscal cliff fast approaching many investors are preparing to sell their biggest winners to avoid the coming increase in capital gains taxes when automatic increases hit next year. With all the political posturing, we are not likely to see a resolution to the automatic spending cuts and tax increases before year end. What we will see is both political parties pointing the finger at the other and the blame game will go on as usual.

The prospect of higher taxes will have many investors selling winners in order to maximize gains this year and holding onto losers for next year -- just the opposite of the normal year-end planning strategy most investors employ. Corporations are also looking to move as much of their dividend payments schedule into this year to help protect shareholders from bigger tax bills. A record number of US companies, big and small, are signing off on special dividends to be paid before the end of the year. Propelling the rush is the risk that the current low tax rate of 15 per cent on dividends will disappear come January 1st.

The current tax rates on capital gains and dividends came into effect under the last Bush administration. The Bush tax cuts, passed in 2003, lowered the top rate paid on dividends from 38.6 percent. Now there is a risk that the top rate could hit 39.6 percent, with an additional 3.8 percent on top of that to help pay for the new healthcare law. In response, since October over 100 companies have said they will pay special dividends or make additional payouts before the end of the year. The pace has picked up since the election results and the attention of investors has focused on the fiscal cliff negotiations.

This is the not the first time in recent years that special dividends have spiked in the fourth quarter. In 2010 there was a similar rush from companies, only for Washington to delay ending the Bush tax cuts.

Much of the heavy selling is also most likely related to fiscal cliff-related selling. The mass sell-off of Apple's (AAPL) stock, for instance, is definitely being driven by the looming fiscal cliff. Apple's share price fell as low as $505.75 in recent trading, although it eventually recovered and has moved back into the $580's. The low represented a loss of $200, or more than a quarter of its value, since the stock hit its all-time high of $705.07 back in September. The decline has also shaved about $170 billion off the company's market capitalization; although, with a Market Cap of $493 billion it's still the most valuable U.S. company.

Apple's stock finished 2011 at $405.12, meaning if you picked up the stock as last year closed and sold the stock in December you would be looking at a tax bill of around $27 in capital gains. If you wait and sell those shares in January you would be looking at an additional $9 in taxes for every share you sold. Long term holders of Apple could potentially be looking at hundreds of dollars in additional taxes by selling after January 1. With the prospect of huge tax bills many Apple shareholders will be forced to part with their shares and move those funds into other investments.

Apple's stock price was already under pressure from problems with its iPhone 5 release and changes to top management; so even if the fiscal cliff is averted, the stock is not likely to soar. This year may turn out to be the peak year for iPhone profit margins. This has been a nearly perfect year for Apple, with the iPhone's old rivals dying just as the new ones have only gotten going. The first wave of Google (GOOG) Android smartphones were buggy, junky and fell far short of the new standard set by Apple. Then Samsung came into the market in 2010 and by 2011 had traction with beautiful phones such as the Galaxy and the Note.

The vacuum left by Steve Jobs may impact the company for a decade or more, and in the end he may prove irreplaceable. He was superb at pulling the best out of people, sometimes against their wills, and often at the cost of eventual burnout and mutual hatred. Tim Cook, Steve Jobs’ replacement and the company's top operations manager under Jobs, has performed well as Apple's new CEO. Apple shares are up more than 49% since Jobs' death despite the drop of the last two months, but Mr. Cook has steered an Apple already moving forward on momentum created by Jobs.

All together it may be more than the stock can handle and we may be in for a period of stagnation in value over the next year or two. Now may not be the best time to buy this stock, but an option strategy that looks really good is a bear call spread.

Investors looking for a hedged trade on Apple may want to consider the February 680/685 bear-call credit spread. In this trade the investors will sell the February 680 calls while buying the same number of February 685 calls for a 60 cent credit or better. The trade generates a 13.6% return (66.4% annualized) and the stock has to rise 15.4% in the next 75 days to cause a problem.

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