All Eyes on AT&T Ahead of Apple Earnings

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- Everything changes after a $90 selloff. Apple ( AAPL) hit $556 on Monday morning and all of a sudden it looks like the 50/50 odds of iPhone weakness is already priced in. Two weeks ago, we figured the stock would rise $100 if Apple beat iPhone estimates and it would drop $100 if it missed.

Investors, including us, have given the majority of their attention to the negative 50% odds, but what about the positive 50%? We know that Verizon iPhone sales declined by 1 million units from the holiday quarter and we will find out what happened at AT&T ( T) when it releases results on Tuesday morning. Verizon and AT&T are both important pieces to the puzzle but 63% of iPhone activations occurred outside of the U.S. last quarter.

The March quarter is the monster quarter for international iPhone sales because it includes the Jan. 13 launch of the iPhone 4S in China and the March 9 launch of the iPhone with China's newest carrier, China Telecom. China has become Apple's second most important market in terms of revenue and this is the launch quarter for them. Can Chinese iPhone sales compensate for the 1 million Verizon drop and maybe another 1 million drop from AT&T? Easily.

The Street is now expecting sales of 31 to 32 million iPhones in the quarter. What do we expect? If you take the 24% Verizon sequential decline across the board from the holiday 37.04 million iPhone number it gives you 28.15 million units. However, there are two important numbers to factor in. iPhone sales grew 117% sequentially because of the iPhone 4S launch. With 20% of revenue coming from China, it's rational to assume that a 117% rise in Chinese demand could result in an extra 7 million iPhone's sold (especially considering there were 21 additional launch countries on January 13th) which gets Apple to 35 million units in the quarter.

The other scenario to consider is that Verizon may prove to be a terrible barometer for iPhone sales. We'll find out more on Tuesday morning after the AT&T report, but let's assume AT&T sales come in sequentially flat or down approximately 10%. It could happen. A year ago iPhone sales actually increased by 15% from the holiday quarter to the first quarter (this same scenario is unlikely, however, because iPhone 4S launched in the holiday 2011Q). Let's assume a 10% reduction across the board instead of a 24% reduction. That puts us at 33.3 million iPhones before adding in the Chinese demand. Add in China and the iPhone number hits 40 million.

At this moment, we think there is a 50% chance that Apple will beat estimates and will report sales of 35 million iPhones. Those odds are much more appealing with Apple trading at $570 than they were with Apple trading at $644. If AT&T shows better iPhone results than Verizon, then the chances that Apple sells more than 35 million goes up above 50%.

We are going to make our portfolio allocations dependent upon AT&T. Our first move for today is to sell out of the 2% allocation of AAPL April 2012 $600 puts that are up 60% since we bought them on Thursday. Tomorrow, we will add a new 10% allocation of AAPL October 2012 $550 calls if AT&T shows better than Verizon. If AT&T shows that it is sequentially flat or even up over the holiday quarter, then we will add an additional 10% allocation of AAPL May 2012 $560 calls to take advantage of the rapid recovery that will quickly occur.

Earnings season is a volatile time which is why you want to take profits beforehand. By having over 80% of the portfolio at in cash, we are able to take advantage of unforeseen selloffs. The $90 correction in AAPL marks a great long-term entry point.
At the time of publication, the author was long AAPL.

Jason Schwarz is an option strategist for Lone Peak Asset Management in Westlake Village, Calif. He is also the founder of the popular investment newsletter available at Over the past few years, Schwarz has gained acclaim for his market calls on the price of oil, Bank of America, Apple, E*Trade, and his precision investing in S&P 500 option LEAPS. His book, The Alpha Hunter, is set to be released by McGraw Hill in December 2009.