The Charles Schwab Company (SCHW) produced slightly better earnings than expected on April 17, although revenue fell short. This has led to unusual put option activity in an out-of-the-money strike price for expiration in June. That could also provide an income play for investors, assuming no recession hits the U.S. economy.
I have discussed options activity in SCHW stock in several prior articles, including this one on April 14, “Investors Are Piling Into Schwab Puts, Shorting Them for Income.” I discussed shorting the $40 strike price puts for expiration on May 19, given that the stock was at $51. The premium of 43 cents provided a 1% premium-to-strike yield or 12% on an annualized basis.
In today's Barchart Unusual Stock Options Report, investors have been trading the $40 strike price for expiration on June 2, 2023. At that strike price over 11,500 puts were traded, which is unusual since it is over 53 times the existing number of contracts (open interest).
As a result, investors can copy this trade by shorting the $40 strike price and receive 31 cents, or a 0.775% yield based on the strike price. That works out to a 9.3% annualized return assuming it can be repeated each month for a year.
This is likely to be a good trade, as the May 19 $40 strike price put trade we discussed in the last article is now down to 10 cents on the bid side from $43 cents. So what is going on here?
SCHW Stock Looks Cheap
On April 17, The Charles Schwab Corporation reported 10% higher revenue and 12% higher adjusted net income compared to a year ago. This income was slightly lower than investors expected although revenue was lower than analysts had forecast.
Nevertheless, the company's return on average equity was 23% compared to 12% a year ago. This indicates a substantial rebound in its earnings power and allays concerns that the company might have been hurt by investors worried about a potential recession.
Moreover, analysts still project good earnings per share (EPS) for 2023 - $3.33 per share for 2023 and $4.20 for 2024. That puts SCHW stock on forward multiples of 15x and 12x respectively. Both of these multiples are well below the 18.9x average P/E ratio that the stock has had over the last 5 years, according to Morningstar.
This implies that SCHW stock could move higher here, assuming a major recession does not hit. For example, 18.9x $3.33 EPS results in a target price of $62.94, or 23.6% higher than today's price of $50.93.
In addition, SCHW presently has almost a 2.0% dividend yield at today's price of $50.93 (i.e., $1.00/$50.93=1.96%). This is substantially higher than the average 1.24% dividend yield SCHW stock has had over the past 5 years, also from Morningstar. That implies the stock could rise to $80.65 (i.e., $1.00/0.0124), or 58% higher.
The bottom line is SCHW stock could be worth between 24% and 58% higher than today. That is probably why shorting the out-of-the-money puts in SCHW stock is popular with investors as seen in today's Unusual Stock Options Report.
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.
