Investors in Charles Schwab (SCHW) stock should consider selling out-of-the-money (OTM) puts for near-term expiration. SCHW stock is cheap enough that this strategy allows you to both make extra income and provide a way to lower your average buy-in cost if the short put trade is exercised.
I have written several articles about this trade in the past months, including this one on June 5, “Charles Schwab Stock Remains A Popular Short Put Play For Income Investors,” and this one on May 14, “Schwab Stock Is Still Cheap, Making Short Puts A Very Popular Income Play.”
In both articles, I pointed out that SCHW stock could be worth between $62.94 and $80.65 per share. Today (June 23) SCWH stock is at $53.17, down just slightly from $54.40 when the June 5 article came out.
When a stock is reasonably stable like this, it makes sense to short OTM puts with near-term expiration periods. It allows the investor to consistently pick up extra income.
To be fair, the same could be said about selling covered calls, i.e., selling short OTM calls at strike prices above today's spot price. But at least in the case of shorting OTM puts, if it is exercised the investor does not have to sell their existing holdings. The opposite is true, they get to buy in at a lower price, thereby lowering the average cost.
Shorting OTM Puts Still Makes Sense
For example, in my June 5 article, I pointed out that the $50 strike price puts expiring on June 30 traded for 54 cents per put option. That presented an immediate yield of 1.08% (i.e., $0.54/$50.00), for a strike price that is still $4.40 below the spot price, i.e., 8% away from $54.40.
Today (June 23), two and half weeks later those put premiums have deteriorated to just 10 cents for the $50 strike price. That is exactly what a short-put trader wants to see. The goal, in fact, is to see if the put can expire worthless. That way there is no obligation to purchase the stock at $50.00, the strike price.
Moreover, the investor makes 100% of the 1.08% yield income that was collected at the time the put was sold short.
Now, in fact, it makes sense to roll this trade over or to initiate a new short put trade in SCHW stock put options. We can either wait for the June 30 puts to expire worthless and/or we could also begin a new short trade for July 14, which is 20 days from now.
Shorting the July 14, 2023, SCHW Put Options
For example, the $50.00 strike price puts for July 14 trade for 44 cents per put contract. That represents an immediate yield of 0.88% (i.e., $0.44/$50.00) for expiration in less than 3 weeks.
This means that a trader who secures $5,000 in cash and/or margin with their brokerage firm can then enter an order to “Sell to Open” 1 put option at $50.00. The brokerage account will then immediately receive $44.00 in it. That is why you can see this represents a 0.88% yield.
In fact, if it can be repeated every three weeks for a year, i.e., 17 times a year, the investor could make about 15% just by successfully selling OTM SCWH puts. You can see in the option chain above that the $50.00 strike price is about 6% below today's price. A trader willing to take on more risk could short the $51.00 strike price, 4% below today's price.
That strike price has a 63 cents premium, providing an immediate yield of 1.24% (i.e., $0.63/$51.00). That has a higher degree of risk that SCHW could fall to this price and force the trader to purchase the stock at $51.00 (unless the trader closes out the trade by buying back the short put).
If this trade is repeated every 3 weeks for a year, the annualized return is 21%. So investors should decide whether they are willing to take on additional risk for a 21% annualized return vs. a 15% annualized return.
Nevertheless, this shows that investors can produce good additional income by shorting out-of-the-money SCHW put options.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
