Target (TGT) stock rose nearly 11% Wednesday on better-than-expected Q2 2024 results. The Minneapolis-based retailer beat analyst estimates on the top and bottom lines and raised guidance for the remainder of the year.
I don't think there's any question long-term investors would view Target stock as a good investment. I know I do.
Certainly, CEO Brian Cornell has done an excellent job running the business since taking over in August 2014, despite the two-year downturn between August 2021 and August 2023. It’s on the mend.
However, my commentary today is focused on unusual options activity. Yesterday, Target had 17 unusually active options—defined as a Vol/OI ratio of 1.24 or greater and expiring in seven days or more—with 12 calls and 5 puts.
If you’re an income-focused investor, I’ll evaluate whether a covered call or a naked put is a better move.
Here’s my two cents. The Covered Call
In this situation, you already own Target stock and would sell call options to generate income. Further, to hang on to the stock after expiration, you don’t want the share price to rise above the strike price.
Using Barchart’s Covered Call Option Screener, I’ve identified one available call.
In the first example, you buy the stock at $159.25 (yesterday’s closing price), and sell the $185 strike, generating premium income of $3.20, for a net debit of $156.05. That’s the net cost of buying 100 Target shares.
So, if the shares don’t move over the next 150 days, your return is 2.1% ($3.20 divided by $156.05). On an annualized basis, that’s 5.11%. That’s about what a Treasury bill pays.
Now, if you buy 100 Target shares at $159.25, and they appreciate to $185 or higher by expiration, they’ll be called away, generating an 18.6% or 45.4% annually. That’s good, but remember, if it appreciates to $200, you don’t get any of that unless you buy another 100 shares.
Finally, let’s say you bought 100 shares last November at $110 where they were trading, and you sell one $185 call. If its share price is $170 at expiration in January, your return would be 64% based on $60 per share in capital gains, $3.20 in premium, and dividends of $6.66 (six quarters). On an annualized basis, that’s 55% (12 months / 14 months * 64%). Plus, you still own 100 Target shares.
Here’s the Target call from yesterday’s trading with the highest unusual options activity and trading out of the money.
Based on buying at the closing price of $159.25, the potential return if it reaches $165 by expiration is 4.2%. That’s an annualized return of 170%. Plus, the probability of being out of the money is still high at 77%.
If I had bought TGT back in November for around $110, I’d be much more inclined to take the $165 call because it expires much sooner.
The Naked Put
As I always point out, I remain a newbie despite writing about options for over two years. Every time I write about them, I learn something new, or at least another way to analyze them. You can never stop learning.
Selling puts is an excellent way to gain a better entry point for stocks where you’re bullish about the future. Target is one such stock.
In yesterday’s trading, there were five unusually active put options with Vol/OI ratios ranging from 7.20 to 1.56.
As I write this in late Thursday morning trading, Target’s shares are around $159, down 25 cents from yesterday’s close. Thus, not much has changed on the unusual options activity front.
Adding the five unusually active put options from today’s action, four expire a week Friday, two in two weeks, and four with DTEs of 30 days or more, providing a considerable variety.
Remember, you ultimately want to own Target stock, but it might not be $159. What to do?
There are three puts with strike prices of $152.50 or lower. I’d start with these. The two at $150 expire in eight days (Aug. 30) and 86 (Nov. 15); the former’s OTM probability is 91%, while the latter’s is 73%. The $152.50 strike that expires Aug. 30 has an OTM probability of 88%.If you want income for now, you’ll be better off going with the $150 strike expiring next Friday. It has an annualized total return of 7.8%. That’s better than a Treasury bill.
However, if the goal is to own Target stock for the long haul, the $150 strike expiring in November seems like an interesting bet. The annualized return is 8.8%, 100 basis points higher than the Aug. 30 $150 strike.
You might be thinking: Why would I expose myself to greater time risk for a mere one percentage point return? Good question.
The Bottom Line
As I said earlier, the November put has a 73% probability of expiring out of the money. That’s still reasonably high, but there’s no question there’s greater risk.
However, you could do a Bull Put Spread by buying a lower strike price with a Nov. 15 expiration simultaneously (see below).
You simultaneously sell the Nov. 15 $150 put ($3.20 bid) and buy the $145 ($2.18 ask). Your net credit would be $1.02 ($3.20 - $2.18).
Unfortunately, while your maximum loss would be $398 ($150 - $145 - $1.02), your maximum gain has been reduced from $320 to $102.
Is Target’s share price going to fall by $12 over the next three months after reporting excellent earnings and raising its earnings per share guidance for 2024 to $9.35 from its previous estimate of $9.10?
I doubt it.
Besides, the goal is to get a better entry point while padding your cash account. For me, the bull put spread defeats the purpose and becomes a straight-up income play.
That’s not the Target—pun intended! Between the Covered Call and the Naked Put, I like the latter because it offers a better entry point while generating income.
On the date of publication, Will Ashworth 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.
