Investors who have shorted out-of-the-money puts in Charles Schwab (SCHW) stock have been making good money. SCHW stock is still cheap based on earnings, making this a good play for investors.
I have written several articles about this trade in the past months, including this on May 14, “Schwab Stock Is Still Cheap, Making Short Puts A Very Popular Income Play.” In that article, I pointed out that SCHW stock could be worth between $62.94 and $80.65 per share. This is based on its historical value metrics.
Historically Cheap
As of June 5, SCHW stock is trading at $54.40 and analysts estimate that its earnings for 2023 will be $3.32 per share and $4.19 for 2024. That puts the stock on a forward P/E multiple of just 16.4x for 2023 and 13x for 2024.
However, Morningstar reports that Schwab stock has had an 18.8x forward P/E multiple over the last 5 years. The same is true with Seeking Alpha. Their calculation is that the average P/E over the past 5 years has been 20.4x.
This implies that at 19x 2024 earnings SCHW stock could be worth $79.61 per share (i.e., 19 x $4.61). That means the stock is still undervalued and could be worth 46% more if it were to trade at its average P/E multiples.
As a result, long investors in SCHW stock can hedge their bet by shorting out-of-the-money puts in order to create extra income. This play also allows the investor to potentially average down their cost should the stock fall from here.
Shorting Out-of-the-Money SCHW Stock Puts
In my last article, we pointed out that shorting the June 9 expiration $44.00 strike price puts were trading for 74 cents. That provided a juicy premium yield of 1.68% (i.e., $0.74/$44.00) or 20.1% annually. Today those puts are trading for about 1 cent, so it makes sense to simply buy them back and close out the trade at a huge profit.
Next, the investor might like to roll this trade over by shorting the June 30 expiration $50 strike price puts. Today they are trading for 54 cents per put contract. That represents an immediate yield of 1.08%, for a strike price that is still $4.40 below the spot price, or almost 8% away from $54.40.
This means that the investor who secures $5,000 with their brokerage firm can enter an order to “Sell to Open” one put contract at the $50.00 strike price. Their account will immediately receive $54.00. That means if the investor could do this each month for a year they could make $648 in income, which is a 12.96% return on the $5,000 invested with this short put strategy.
Moreover, as you can see, a more aggressive investor could short the $51.00 strike price, which is just 6% below today's price, but the premium is much higher at 73 cents. That represents a 1.43% immediate yield to the short put investor or 17.1% on an annualized basis.
This shows that the long-term investor in SCHW stock can make extra income by shorting out-of-the-money puts. They also provide the opportunity to potentially average cost in their position at a lower price should the stock fall.
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.
