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HP Inc. (HPQ), the hardware company, not HP Enterprises (HPE), gave good guidance on February 28 for its FY free cash flow this fiscal year ending Oct. 31. That could push the value of HPQ stock 14% to 19.5% higher. This makes short-put plays attractive, especially for existing shareholders, as an income play.
I discussed this recently in a Barchart article on Feb. 28, “Unusual Put Options Activity Today for HP Inc Ahead of Its Earnings Highlights Its Value.” At the time HPQ stock was at $28.96 and I discussed selling short the April 19 expiration $25.00 strike put options. Those puts were trading at 22 cents, giving the short seller a 0.88% yield.
Today, with HPQ stock at $29.82 per share, those puts are at just 4 cents in the midprice. That makes this an already profitable trade for investors.
Moreover, it makes sense for investors to consider shorting more near-term expiry puts as the company's earnings and free cash flow (FCF) guidance were very positive.
HP's Free Cash Flow Guidance
HP said it generated just $25 million in FCF during its latest quarter ending Jan. 31. However, for the full fiscal year ending Oct. 31, it now expects to see between $3.1 billion and $3.6 billion.
That represents an FCF margin of about 6.33%, based on analyst estimates of $53.66 billion using a mid of $3.4 billion. Moreover, if the market gives the stock a 10% FCF yield, its market cap could reach $34 billion (i.e., $3.4b/0.10). That represents a gain of 14% over its existing market cap of $29.77 billion.
In addition, next year analysts forecast $55.6 billion in revenue. As a result, using a 6.4% FCF margin, FCF could reach $3.558 billion. That implies, using a 10% FCF yield, that HPQ stock could eventually be worth $35.58 billion sometime in the next 12 months. This is 19.5% over today's today's market cap.
So, the range of the stock's value is 14% to 19.5% higher or $34.00 to $35.64 per share.
That means it might make sense to continue shorting near-term expiry out-of-the-money (OTM) put options for extra income.
Shorting OTM Puts for Income
For example, look at the expiration period ending April 5, less than three weeks away. It shows that the $28.50 strike price, 4.00% below today's price, trade for 12 cents on the bid side. That represents a yield of 0.60% (i.e., $0.17/$28.50).
In addition, the $29.00 strike price puts trade for 25 cents for less risk-averse investors. Those puts are 2.36% below today's price and have a yield of 0.86%.
This is not without a good deal of downside risk. So, investors who make these trades must know that their cash secured to do the shorts could be exercised if the stock falls to $29 or $28.50 within the next 3 weeks. Then they would be used to buy shares at the strike prices they shorted.
One way to potentially avoid this is to sell short further out expiration strike prices. For example, the April 19 expiration shows that the $27.50 strike price puts, trade for 11 cents on the bid side. That still represents a yield of 0.40% for the strike price which is 7.84% below today's price.
The bottom line is that HPQ still looks undervalued here given the company's free cash flow guidance. As a result, it makes sense to short out-of-the-money put options for extra income, especially for existing shareholders.
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.
