Western Alliance Bancorp (WAL) stock is up over 5% today to $34.92 now that Silicon Valley Bank has been rescued by the FDIC and bought over the weekend by First Citizens Bancshares (FCNCA). However, despite that good news, WAL stock option premiums are still high, which might indicate the bank stock could be volatile. This is good news for income investors who short its puts and calls.
We discussed this issue in our last article on the Phoenix-based regional bank stock on March 14 in our article, “Western Alliance Bancorp Is Up Big on Citadel Purchase of 5.4%.” In the article, we showed that WAL trades well below its tangible book value per share (TBVPS) of $40.25, from last quarter. In fact, even with a 20% haircut, the TBVPS might be $32.40 at the end of March. This still makes the stock cheap at just 1.08x adjusted TBVPS.
There is other good news. First, a large hedge fund run by Ken Griffin, Citadel, has bought a 5.4% stake, and the bank has already raised $25 billion to cover potential withdrawals. In addition, Western Alliance Bancshares still pays a 1.44 per share annually, which gives the stock an attractive 4.1% dividend yield. If the market thought the bank might cut the dividend, the stock would have stayed in the mid-$20s.
These factors are attracting value investors who see that its out-of-the-money (OTM) stock option premiums are still high.
Shorting WAL Stock Out-of-the-Money Puts and Calls
In my last article, I suggested that it was optimal to short the March 17 out-of-the-money puts at $20.00, and even to buy the $17.50 puts as a long hedge. That trade ended up being profitable. Now, given the high options premiums, it makes sense to look out for one month and short OTM puts and calls.
For example, the April 28 expiration puts at the $25.00 strike price, which is 28% below today's price with just 32 days to expiration trade at $2.25 in the midpoint. That provides investors an immediate 9% yield (i.e., $2.25/$25.00) on a put-to-strike basis, which is incredibly high. Even on a put-to-spot basis, sort of like covered call investors make, the yield is high at 6.44% (i.e., $2.25/$34.92).
Moreover, even the $20 strike price puts, a strike price 42% below today's price, sports a premium at $1.40. This provides an immediate 7% yield on a put-to-strike basis (i.e., $1.40/$20) and 4.0% on a put-to-spot basis (i.e., $1.40/$34.92).
A similar situation occurs with OTM short calls, or covered calls. For example, the April 27 $45.00 strike price calls trade for $1.66 per contract. That provides a covered call yield of 4.8%. The WAL stock will have to rise over 29% before that call option could ever be called and it would have to happen in the next 32 days.
This is extremely attractive to value investors, who might want to go long the stock at today's price, given its high dividend yield. By shorting this OTM call the investor sort of gets a double yield (i.e., 4.1% annual dividend yield, plus 4.8% one-month OTM short call yield). This is because the investor probably does not expect to see the stock up 29.5% in the next month, but even if it happens, they will be happy to take the capital gain.
In fact, some investors might be shorting both OTM WAL stock puts and calls, although that will require twice the capital to be put up (i.e., cash-secured puts require cash and/or margin equal to the exercise of the put strike price option). Either way, investors are now looking at WAL stock options, given their high premiums, to enhance their income.
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.
