Investors in Charles Schwab Corp (SCHW) stock have found that it is still cheap, as we discussed in recent articles. As a result, shorting its out-of-the-money puts has now become a very popular income play.
For example, we argued in our recent article, “Schwab Puts Show Unusual Put Activity,” on April 26 that SCHW stock was deeply undervalued. We showed that it could be worth significantly more since its average price-to-earnings (P/E) multiple was well below its historical average. In addition, the stock's dividend yield was well over its 5-year average.
As a result, the stock could be worth between $62.94 and $80.65 per share. At today's price of $48.94, that means that SCHW stock could be worth 29% to 65% more.
Shorting Puts for Income Is Very Popular
In that article, we pointed out that investors were shorting out-of-the-money (OTM) puts at the $40.00 strike price for expiration on June 2. At the time, the stock price was $51.03 and the $40.00 puts traded for 31 cents. This means the investor received an immediate yield of 0.775%, or 9.3% if repeated each month for a year.
Today SCWH stock is slightly lower at $48.94, but the put premiums for the $40 strike price are significantly lower at 18 cents for the June 2 expiration period. That means the short-put investors have made a good return of 41.9% on their short investment.
Moreover, unless SCHW stock falls to $40 on or before June 2, the $40 puts are likely to expire worthless. That means the investor gets to keep 100% of the 0.775% yield. Given that many of the 11,500 of these puts traded at this level were likely initiated as short put trades, this has become a very popular strategy with hedge funds and other institutional investors.
Moreover, a similar result has been achieved based on our article on April 14, “Investors Are Piling Into Schwab Puts - Shorting Them for Income.” For example, we argued that the $40 puts expiring on May 19, which traded at 43 cents were good shorts to create income. Today, those puts have dropped to between 2 and 3 cents. That means that investors who shorted those puts have made almost all of the 43 cents shorted, which yielded over 1.0% at that strike price.
The same was true for the $45.00 strike price expiring on May 19. At the time the puts were at $1.13, and today their price today is 16 cents at the midpoint. That shows that the investor has already made 97 cents on their short-put investment, or 85.8% of the original $1.13 premium. Note that the premium yielded 2.5% (i.e., $1.13/$45.00), and the investor has now made most of that yield.
Attractive Short Puts in SCHW Stock
Investors can short the $44.00 put for expiration on June 9, 27 days from now, and receive $0.74 immediately. This is a very attractive short put trade since the $44.00 strike price is 10% below today's spot price of $48.94, and the 74 cent premium represents a premium-to-strike yield of 1.68%. That works out to an annualized return of over 20.1% if the trade can be repeated each month for a year.
In effect, this means that the investor who secures $4,400 in cash and/or margin with a brokerage firm can then enter in an order to “Sell to Open” 1 put option at the $44.00 strike price. The account will immediately receive $74.00. And unless SCHW stock drops over 10% between now and June 9, 27 days from now, that put option will likely drop to zero by then. This means the investor will keep all the income and not have to purchase the stock at $44.00.
The open interest in this strike price and other strike prices close to it have been rising. That shows that these puts have been popular with investors. A good portion of that interest is likely from investors who initiate the trade as a short-put income play, as we have shown.
This is due to the increasing recognition by the market that SCHW stock is likely too cheap here.
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.
