The Charles Schwab Corp (SCHW) stock has tumbled 11% in the last month, trading just below $51 on Friday, April 14 ($50.72). This makes its put options very popular with investors. They are shorting near-term out-of-the-money (OTM) puts in an attractive income opportunity. In effect, this is a bullish trade on SCHW stock.
On March 15, 2023, I wrote about a large investor with an unusual options trade in Schwab stock: “Unusual Call Option Activity In Schwab Stock Shows Bullish Investor Position.” In that article, I showed that a large investor had likely shorted OTM calls at the $80 strike price for expiration on May 19.
The investor received 89 cents at the time when SCHW stock was at $57.73. This provided a short-term income yield of 1.54%, or 18.5% on an annualized basis if the trade can be repeated each month for a year.
So, at today's price of $50.72, the shorted OTM call at the $80 strike price is now trading at zero. This was a very successful trade for the investor. That makes us wonder if shorting OTM puts in SCHW stock could be profitable for the same expiration period.
Shorting OTM Puts in SCHW Stock
For example, the chart below shows that there are several strike prices in this expiration period (May 19) with OTM puts that are popular with investors. The $40.00, $42.50, and $45.00 strike price puts have had large increases in volume.
These strike prices are 12% to 21.78% below today's spot price, showing that they are very far out-of-the-money (OTM) and have just over a month or 35 days to expiration. That makes it highly likely that the initiating put trades were done by investors who were shorting these puts. They did this to capture the high premiums as income.
For example, the investors who shorted over 2,400 puts at the $40.00 strike price made 43 cents on average. That is over 1.0% ($0.43/$40) or 12% annually and would require the stock to fall almost 22% in just over a month before the puts could be exercised. That does not seem likely, unless, of course, Schwab reports truly horrible results for Q1.
The same is true for the $42.50 strike price puts, which provide a 1.65% yield opportunity (i.e., $0.70/$42.50), although the strike price is almost 17% below today's price. Similarly, the $45.00 strike price put options, 12% below the spot price, trade for $1.13, and provide a 2.5% income opportunity. Those investors must feel that SCHW stock won't fall below $43.87 (ie., $45.00-$1.13) which is the breakeven price that is 13.5% below today's price.
Where This Leaves Investors
To be sure, it is not completely impossible for SCHW stock to drop over 12% to 22% in the next month. For example, the company's book value per share is just $14.52 per share as of Dec. 31. If Schwab reports a massive hit to their balance sheet, or if it is clear that investors stop trading due to a sudden market drop, SCHW stock could easily crater.
However, as I pointed out in my last article, Schwab stock looks cheap here. Analysts project $3.75 in earnings per share (EPS) for this year and $4.62 next year. That assumes the U.S. economy will not hit a major recession. As a result, its forward P/E multiple is just 13.8x and 11.1x respectively. Those are moderate forward multiples.
In fact, Morningstar reports that over the past 5 years, SCHW stock has had an 18.8x forward multiple. That is 39% to 69% over the 2023 and 2024 existing P/E multiples today.
The same is true with the stock's 1.97% dividend yield today. The average dividend yield over the last 5 years has been 1.24% in the last 5 years.
In fact, even in the last 12 months, the average yield has been 1.74%. That means that if we dividend the $1.00 annual dividend per share by 1.74%, SCHW stock should trade at $57.47 per share (i.e., $1.00/.0174 = $57.47). This implies a 13.3% potential upside in SCHW stock just to get back to its average dividend yield in the last 12 months.
So you can see why investors are piling into shorting these OTM puts for May 19. They are taking advantage of excessive pessimism on SCHW stock in order to create income in the short term.
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.
