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Palantir Technologies (PLTR) stock is worth considerably more than its present price given its huge free cash flow and management's forecast. Shorting a 5% OTM put for March 22 expiry produces a 2.26% yield.
I discussed this strategy in my last Barchart article on Feb 11, “Palantir's Massive FCF Margins Could Push PLTR Stock's Value 25% Higher to $30 Per Share.” At the time, PLTR stock was trading for $24.38 per share. Today it's at $25.04.
I suggested that selling short the $23.00 strike price put was worth doing. It yielded 2.826% for just 3 weeks to expiration on March 1 (today) expiration), as the premium was 65 cents per put contract. Today those puts are trading for 2 cents on the offer side.
In other words, this has been a success. The investor collected the premium, made almost 3%, and has had NO obligation to buy the shares at $23.00 per share. PLTR stock is well above the strike price and the put contract is 7.85% out-of-the-money (OTM) (i.e., $23.00/$24.96-1).
Shorting OTM Puts Again
So, it makes sense to close out this trade (i.e., enter an order to “Buy to Close”) for 2 cents and turn around and do it again. For example, look at the March 22 expiration period for PLTR.
This shows that the $23.00 put trades for 52 cents, 7.85% OTM, and the $23.50 put strike price, 5.85% OTM, is at 67 cents on the bid side.
In other words, the $23.00 short put play yields 2.26%, and the $23.50 short put play yields 2.85%, although the latter is closer to the spot price.
This means that the investor who secures $23,500 in cash and or margin with their brokerage firm can enter an order to “Sell to Open” 10 puts contracts at $23.500 for expiry on March 1. The account will then immediately receive $670.
So, the investment yield is 2.851%. Moreover, if this trade can be repeated every 3 weeks for one quarter, the expected return (ER) for the investor is $2,680, or 11.4% over the period. That is a very good return and helps provide significant downside protection for any long investor in the stock.
How to Handle This Play
As I wrote in my last article, the long-term investor can expect that the stock will be worth $30 or more.
However, analysts surveyed by AnaChart, a new sell-side analyst stock recommendation tracking service, have an average price target now of $23.87 per share, or roughly at today's price.
So, just to be conservative, some investors might want to buy put options at strike prices lower than the short put strike price.
For example, the $20 strike price put trades for just 9 cents per contract. That allows the investor to have the comfort of knowing that any price at $20 or below will be covered.
So, let's say that the stock falls to $23.00. The investor would be obligated to purchase the stock if they hold the short put contract until the expiration on March 22. However, the put price for the $20 long put holding could have risen. That helps offset any potential increase in the short-put price.
Moreover, it acts as a downside protection in case the stock falls to $20 or below once the investor purchases the stock at the expiration price.
Nevertheless, given the upside potential in Palantir, based on its powerful free cash flow, investors in PLTR stock can make extra income by shorting these high premium 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.
