PepsiCo (PEP) has said it will hike its dividend by 5% but has not yet set the exact dividend per share (DPS) amount - expected next month. One way to play this is to short out-of-the-money puts and to buy in-the-money (ITM) long-dated calls with the short-put proceeds.
PEP is at $149.85 in midday trading on Tuesday, March 18. That is up from a recent low of $143.39 on Feb. 13, 2025, but well off its 6-month high of $176.52 on Oct. 14, 2024.
Today, PEP stock has a 3.61% dividend yield with its present annual $5.42 DPS. I discussed the company's upcoming 5% dividend hike in a Feb. 14 Barchart article, “PepsiCo Hiked Its Dividend 5% and its Yield is over 3.93% - A Buy Now for Value Investors?”
PepsiCo's Feb. 4 earnings release included an announcement of a 5% dividend hike starting with the June payment. The exact DPS number has not yet been set. It won't likely be made until the April 24, 2025, Q1 earnings release.
One Way to Play This Dividend Hike
I discussed this in my last article. I showed that the stock could be worth significantly more based on its historical dividend yield metrics. For example, using the Yahoo! Finance 5-year historical 2.80% dividend yield, PEP is worth $203 using an estimated DPS of $5.69 after the 5% dividend hike:
$5.69 / 0.028 = $203.21
That is over +35% higher than today's price. Moreover, I showed that using its two-year yield average of 3.21%, PEP is worth $177.26, or +18.3% higher than today.
As a result, it makes sense to play this with options. For example, an investor can sell short out-of-the-money (OTM) puts in nearby expiry periods and use the proceeds to buy in-the-money (ITM) call options in long-dated periods.
Shorting OTM Puts
The March 14 $140 strike price put (29 days to expiry - DTE), which was 3.2% below the trading price, had a premium of $1.38 per put contract. That provided the cash-secured short-put investor an immediate yield of about 1.0%.
As it turned out, PEP closed at $148.59 on March 14, so there was no assignment. The stock rose just 2.77%, so existing investors or long-term investors in PEP also made money holding the stock and shorting OTM puts.
In fact, it makes sense to consider buying in-the-money (ITM) long-dated calls using the premium received from shorting OTM puts.
For example, look at the April 25, 2025, put option chain, 37 days to expiry (DTE). The $145 strike price, about 3% below today's price, has a midpoint premium of $2.30. That provides an investor shorting these puts an immediate yield of 1.59% (i.e., $2.30/$145.00 = 0.01586).
Buying ITM Calls
Moreover, look at the March 20, 2026, call option period, 367 DTE (over one year from now). It shows that the in-the-money (ITM) strike price of $135.00, which is almost 10% in-the-money, has a premium of $22.42 per call in the midpoint.
That means that the breakeven price is $135+$22.42, or $157.42, which is just 5.0% higher than today's trading price of $149.85.
The point here is that the investor could end up paying for these call options by repeating the short-put plays each month. For example, if the investor can keep earning $2.30 every 38 days or about 10x over a year (i.e., 365/38 = 9.6x), they could potentially accumulate $22.30.
That almost completely pays for the $22.42 call option premium over a year for the March 20, 2026 ITM call options costing $22.42 per contract.
The bottom line is that this is one easy way to play any upside in PEP stock. Note that there is a 70% delta ratio, indicating a high probability that this will have a chance of profit.
Downside Risks
If the PEP stock falls and stays low the investor could lose money. There is always the possibility that PEP would fall below the short-put breakeven level, i.e., $145.00 - $2.30, or $142.70. But this is 4.77% below today's trading price. The point is that there is a possibility of an unrealized capital loss.
Moreover, there is no guarantee that an investor can make $2.30 per put option contract every month to pay for the ITM calls. Investors should study Barchart's Option Learning Center to analyze these risks. There are sections on Long Call Options and Options Trading Risks.
The bottom line is PEP stock looks undervalued here, given its upcoming dividend hike announcement. One way to play this is to fund long-dated ITM call options purchases by shorting monthly OTM put options strike prices.
