Long Apple Calls against RIMM Calls

Overview

The recent spike in volatility provides an excellent opportunity in shorting long-dated Research In Motion (RIMM) Jan. 2013 $40 strike calls ($4/contract at 44 implied volatility) against long Apple (AAPL) Jan. 2012 $400 strike calls ($26/contract at 32 implied volatility). I would recommend the trade at a ratio of 5 (RIMM calls) to 1 (AAPL calls). The central thesis of the position is to use options to express a bullish view on Apple and a bearish stance on RIMM. The expiration date for Apple is chosen to take advantage of the anticipated excitement of the introduction of iPhone 5 and the potential strong product momentum during the holiday season. Since RIMM has been a volatile stock along with the general volatile market, its option premiums have been highly inflated across all strikes and expiration dates. However, a short-term volatile stock does not necessarily mean a big long-term upside, which depends on the company's future prospect. If the trends for both companies were to continue (there is little evidence to the contrary), the upside for the position can be substantial with very little net premium upfront, which is preferable in the current uncertain and volatile environment.

Key Risks

1. A Turn-around at RIMM

At this point of the race to dominate the mobile devices, it is very hard for RIMM to catch up to Apple and Android. Their main competitor Apple is like the Mongol cavalry under Genghis Khan in the early 13th century. In order to compete effectively, RIMM needs a superior phone and a better tablet at the minimum. In addition, it needs to catch up in the race for apps as well. In other words, it really needs a miracle, and they don't have Steve Jobs as the great Khan.

2. A Disappointing iPhone 5

This is probably the biggest risk of all. However, I think this is highly unlikely given Apple's past track record and its perfectionist culture because Apple would rather delay a product than introducing a half baked device. A delay of the introduction of iPhone 5 until 2012 might be a bigger risk. 

3. A Potential Takeover of RIMM

My thesis of shorting RIMM has been based on its deteriorating competitive position against its competitors. It is always possible that some company may be interested in RIMM as a strategic asset or its patent portfolio as it was the case for Motorola. However, this is highly unlikely after Microsoft decided to push for its own Window phones with Nokia and the rest of the pack joined the Android camp. In addition, RIMM still commands a market cap of about $16 billion, a realistic takeover price tag has to be north of $20 to $25 billion, a hurdle very few companies can clear. To mitigate the potential takeover risk nonetheless, I picked the $40 strike, which is at a 33% premium to where the stock is currently trading. If the deal is in cash, the option premium would evaporate substantially. If the deal is in stock of a bigger acquirer, the call option should trade at a much lower premium, reflecting the lowered implied volatility of the acquirer.

4. Premium Decay

Because of the mismatch of the expiration dates of two calls, the decay on Apple call options is greater than those of RIMM. However, the decay is not significant until December.