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Our analysis shows that Intuit Inc.'s (INTU) stock could be undervalued, but INTU has been trading flat since its earnings release and dividend hike. Nevertheless, shorting near-term out-of-the-money options yields 1.0%.
INTU is trading for $643.96 on Dec. 24, down slightly from Nov. 20 ($650.60), the day before it released Q3 earnings on Nov. 21.
I wrote about how Intuit looked undervalued on Nov. 25: “Is Intuit Stock a Bargain Here? Its Cash Flow Results Imply a 20% Upside in INTU.” The article showed that INTU stock could be worth 20% more at $779 per share.
This makes it worthwhile to use short sale plays with out-of-the-money (OTM) options to generate extra income
Shorting OTM Options for Income
Look at the Jan. 24, 2024, options expiration period, one month from now. Out-of-the-money (OTM) call and put options premiums look very attractive to short sellers.
For example, call options at the $680 strike price have a $5.60 price on the bid side. That means that anyone selling these puts effectively gains $686.60 if the stock rises to the strike price, or a gain of a/most $43 (i.e., $686.60-$643.96 = $42.64).
That represents a potential upside of 6.5% (i.e., $42.64/$643.96) to the covered call investor who sells these calls. But even if the stock does not rise this far in the next month, the short seller makes an initial yield of 0.87%.
Here is what that means. The investor who buys 100 shares for $64,396 can enter an order to “Sell to Open” 1 call option at $680 expiring Jan. 24, 2025. The account will then receive $560. That is why this covered call play makes 0.87% (i.e., $560/$64,396).
Note that this option is 5.74% higher than the stock price and has a low delta ratio of just 0.24. That means there is a just a 24% chance of the stock rising to this strike price.
Another way to play this is to sell short out-of-the-money put options. The investment requires less capital and yields more.
Shorting OTM Puts
For example, using the same expiration period, look at the $610.00 strike price put option. The premium is higher at $5.80 and the strike price is 5.29% out-of-the-money (OTM). That is similar to the OTM distance of the covered call play.
However, the short-put yield is higher since the investment required is lower. The $5.80 premium represents 0.95% or almost 1.0% of the $610.00 strike price.
This means that the investor first secures $61,000 (not $64,396 with the covered call play), and then after entering an order to “Sell to Open” 1 put contract, the account receives $580.00.
The $610 strike price has a low 22% delta ratio as well, similar to the 24% call options delta ratio. That means there is a low probability that INTU stock will fall to this strike price. But even if it does, the investor will have a lower buy-in price, i.e., a lower breakeven.
For example, due to receiving $5.80 already, the investor's buy-in is now $610-$5.80, or $604.20. That is 6.17% lower than today's price of $643.96.
In other words, shorting OTM puts is not only more profitable, but it also has a much lower risk for the investor compared to shorting covered calls. In addition, there would be no realized gain as with exercised covered calls.
The bottom line here is that while INTU is trading flat it makes sense to take advantage of this with short option plays. In both puts and calls, the investor has a chance to make about 1.0% in yield over the next month.
