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Based on analysts' price targets, Oracle Corp (ORCL) stock could still be undervalued despite its recent runup. Moreover, shorting out-of-the-money put options allows one to set a lower buy-in target for ORCL stock and still make some income.
ORCL is at $176.17 in morning trading on Friday, Oct. 11. The stock is up over $51 or +39.9% since Aug. 7 when it reached a recent low of $125.90. On Sept. 9 the company released strong earnings and free cash flow (FCF) results for its fiscal Q1 ending Aug. 31.
At the time I wrote that ORCL was very cheap, worth up to $200 per share. I showed it could be worth this much in my article on Sept. 13, “Oracle Delivers Strong Results and Guidance - ORCL Stock Is Still Cheap.”
Moreover, analysts still see a good upside in ORCL stock. For example, Yahoo! Finance reports that 36 analysts have an average target of $178.49. Barchart's survey shows a mean price target of $178.04.
However, AnaChart.com, which averages recent analyst recommendations, shows that the average of 26 analysts is $190.15. That is closer to my $200 price target and represents an upside of 7.8%.
Shorting OTM Puts Worked
I recommended shorting out-of-the-money (OTM) put options at the $155.00 and $160.00 strike prices (ORCL was at $161.38) for expiration on Oct. 11 (today). Given the stock's rise, these puts will now likely expire worthless.
That means the investor who shorted them made a one-month 1.135% yield for the $155 short-put play (i.e., the put premium of $1.76/$155) and a 2.16% yield at the $160 strike price (i.e., $3.45/$160).
It makes sense to roll this trade over today, given the upside still left in ORCL stock.
More OTM Plays
One way that existing investors in ORCL stock can generate additional income is by selling short out-of-the-money (OTM) puts (i.e., below the stock price) in near-expiry periods. For example, look at the Nov. 8 expiration period, which is 28 days from now.
It shows that the $167.50 put option strike price, which is 5% below today's price of $176.60, trades for $1.65 for each put contract. That means that a short-put play provides a one-month yield of about 1.0% (i.e., $1.65/$167.50 = 0.985%).
Here is how that works. An investor first secures $16,750 in cash and/or margin with their brokerage firm. Then, after receiving approval to do short-put plays, the investor enters a trade order to “Sell to Open” one put contract (which represents 100 shares) at $167.50. The account will then immediately receive $165 (i.e., $1.65 x 100 shs).
That represents about 1% of the $16,750 invested for the next month. As long as ORCL stays over $167.50 up until the close of trading on Nov. 8, the investor's secured cash will not be obliged to buy 100 shares at $167.50.
But even if that happens, the investor has a lower overall breakeven price - i.e., $167.50-$1.65, or $165.85, or $10.75 below today's price. That provides downside protection of over 6% (i.e., $10.75/$176.60 = 6.087%).
In effect, this is a way that existing investors can generate extra income and provide a way to potentially lower their average buy-in cost. Given that ORCL stock still looks undervalued here, this could provide a good expected return (ER).
For example, if an investor repeats this trade every month for 6 months, it provides an additional 6% ER over that period. That assumes that ORCL stays relatively flat. The bottom line here is that Oracle stock looks cheap here and one way to play this is to short OTM puts.
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.
