Rather than just holding HPQ stock with hope that it may go higher this year, collecting a 2.5% yield while waiting, I instead plan to sell options premium this week against my $22 cost basis for a higher return on capital. Implied volatility on HPQ is over 30% and rising as we near the earnings report date of May 29 after the close. Of the past 8 quarterly earnings reports, the stock has ended a few percent lower on only 3 occasions.
I could sell the stock for a tidy gain around 24 where it reached a couple times already this year. The 24 strike at 21 delta means almost an 80% chance the call will expire worthless and I keep the credit of 25, or about 1.1% of the cost. Because after transaction fees, this credit is small, I'd want to instead A) sell the lower 23 strike at 36 delta for $50 credit, or B) also sell an 'out of the money' put for additional credit (forming a covered strangle) if I'm willing to add to the stock position at a lower price on pullback, or C) both. The trade order for a covered strangle would be something like :
SELL -1 STRANGLE HPQ 100 20 JUL 18 23/21 CALL/PUT @1.00
Selling a covered strangle on HPQ is attractive for several reasons: although it means a higher chance of assignment fees at the 30 delta strikes, it brings in nearly 100 credit, which is 4.5% of the current spot price of HPQ (27% annualized). The HPQ daily options volume is only about 8,000 so the 'at the money strikes' closer to the current stock price are the most liquid and easiest orders to fill. At 21 a share adding another lot is a small commitment.
Fundamentally, I believe the stock fair value is higher so I'm willing to risk adding another 1 lot of stock if the stock drops or holding if HPQ trades sideways. The price support around 21 looks solid on the stock going back almost a year. The current Trefis fair price estimate for HPQ is around $25. Based on the 2018 EPS estimate of 1.96, and a long term 5% EPS growth over next 3-5 years, my DCF model suggests a current fair value of $25.50- $27 range.
I could sell the stock for a tidy gain around 24 where it reached a couple times already this year. The 24 strike at 21 delta means almost an 80% chance the call will expire worthless and I keep the credit of 25, or about 1.1% of the cost. Because after transaction fees, this credit is small, I'd want to instead A) sell the lower 23 strike at 36 delta for $50 credit, or B) also sell an 'out of the money' put for additional credit (forming a covered strangle) if I'm willing to add to the stock position at a lower price on pullback, or C) both. The trade order for a covered strangle would be something like :
SELL -1 STRANGLE HPQ 100 20 JUL 18 23/21 CALL/PUT @1.00
Selling a covered strangle on HPQ is attractive for several reasons: although it means a higher chance of assignment fees at the 30 delta strikes, it brings in nearly 100 credit, which is 4.5% of the current spot price of HPQ (27% annualized). The HPQ daily options volume is only about 8,000 so the 'at the money strikes' closer to the current stock price are the most liquid and easiest orders to fill. At 21 a share adding another lot is a small commitment.
Fundamentally, I believe the stock fair value is higher so I'm willing to risk adding another 1 lot of stock if the stock drops or holding if HPQ trades sideways. The price support around 21 looks solid on the stock going back almost a year. The current Trefis fair price estimate for HPQ is around $25. Based on the 2018 EPS estimate of 1.96, and a long term 5% EPS growth over next 3-5 years, my DCF model suggests a current fair value of $25.50- $27 range.
Trade active:
Went wider on the strangle. Earnings report after close today. IV 31.5
SOLD -1 STRANGLE HPQ 100 20 JUL 18 23/20 CALL/PUT @.60
SOLD -1 STRANGLE HPQ 100 20 JUL 18 23/20 CALL/PUT @.60