Today there is large, unusual activity in The Charles Schwab Corp (SCHW) call options that are out-of-the-money. This highlights its value both to those shorting them and those who see SCHW stock rising.
The stock is trading at $59.44 on Wednesday, Sept. 13, down from its recent peak of over $67 per share on July 20. The Barchart Unusual Stock Options Activity Report today shows that over 10,000 contracts for its calls expiring on Nov. 17, 2023, have traded. The strike price is $67.50, which is 13.6% over today's spot price.
Unusual Stock Options Activity
Moreover, the premium for those call options is 71 cents per contract. That means that a long-call buyer of those calls would have to see SCHW stock rise to over $68.21 in the next 65 days before they would have any intrinsic value in those options.
Keep in mind that as the stock price rises closer to the strike price it's possible that the premium could also rise over 71 cents. So long buyers of these calls may be hoping that the stock rises to its former heights.
However, it's also possible that a good number of the call option trades were initiated by short sellers of those calls. They get to collect the 71 cents as income immediately. That works out to a yield of 1.19% on today's price (i.e., $0.71/$59.44).
Typically this trade will be done as a “covered call." They already own the underlying shares and then sell short these out-of-the-money calls. They have to wait 2 months or so to see if their shares will be called away.
These traders expect to see the stock stay where it is over the next 2 months.
Where Things Stand for SCHW Stock
Schwab stock trades for over 18.5 times earnings forecast for 2023 and 14.4 times for 2024. That makes its valuation today relatively high. It certainly is not in cheap territory.
Moreover, its dividend yield is just 1.42%, which is not that high for a financial stock.
In addition, Morningstar reports that the stock is near its historical averages in terms of value metrics. For example, its 5-year historical price-to-earnings multiple is 18.56x. That is close its valuation today of 18.5x forecast for 2023.
In addition, its 5-year historical dividend yield has been 1.31%, close to its 1.42% yield today.
That leaves earnings growth as its only catalyst possibility. Analysts forecast 2024 earnings will rise 28.4% from $3.227 to $4.20. However, that growth rate is likely already discounted in the stock's relatively high P/E multiple today.
Moreover, the company does not have a long history of consistently raising its dividend. That is because its fortunes are highly dependent on the market prospects and related trading volumes.
How This Affects Investors in SCHW Stock
The bottom line here is that this stock is not a bargain, although it does not appear to be overvalued. Moreover, from the standpoint of these out-of-the-money calls that have been heavily traded, it's likely that they were mostly initiated by short-sellers.
By selling covered calls, traders at today's price expect that the stock may not be rising any time soon. For example, the Nov. 17 expiration date is well after the expected Oct. 13 earnings release date for Schwab's Q3 earnings.
That shows that the short sellers of these calls expect that the earnings release won't move the stock significantly higher from today. Keep in mind that the call strike price of $67.50, along with the 71 cents received from the short call trade sets the breakeven price at $68.21.
That means SCHW stock would have to rise 14.75% from today before they would have an “opportunity” loss. That means that they would have to sell their shares at $67.50, but given that they already received 71 cents, the covered call trader has almost a 15% rate of return, including the realized gain.
Meanwhile, they get to keep the 1.19% covered call yield from receiving the call option premium. If that trade can be repeated every two months, the annualized return is 7.14%.
This shows that shorting covered calls in SCHW stock is a good way to increase its present 1.31% dividend yield for long-term 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.
