Morgan Stanley Spikes on Results Making Short Puts Attractive to Income Investors

Morgan Stanley (MS), the investment banking firm, produced excellent results today for Q4. As a result, MS stock is up at least 7% today at $98.19, pushing up option prices. In particular, its put option premiums are now very attractive, compared to call option prices. That means shorting out-of-the-money (OTM) puts for an income play is attracting investors.

On Jan. 17, 2023, Morgan Stanley reported its Q4 earnings per share (EPS) was $1.26. Although this was lower than last year at $2.01 per share, the numbers still pleased investors. This was because the estimates on the street were for $1.23 per share. 

Moreover, the company bought back $1.7 billion of its outstanding common stock during the quarter, and $9.9 billion during the year. That activity helps grow its EPS and makes increases in per-share dividends easier. For example, Morgan Stanley has been consistently raising its dividend every year for the past 9 years.

Options Skewed Heavily Towards Puts

As a result, Morgan Stanley's option prices have been rising, especially on the put side. This means that investors are willing to pay much higher prices for puts than calls for the same strike distance from the present price. This skewness on the put side makes shorting OTM puts very attractive to income investors.

For example, right now the Feb. 17, 2023, options expiration period shows that the $90.00 strike price trades for $1.10 per put contract. That means that the short put investor can make an immediate 1.12% yield on the play (i.e., $1.10/$90.00). Moreover, the investor has at least $8.19 of protection, or 8.3%, before the stock falls to $90.00 and the short-put investor has to purchase the shares at that price.

This means that the investor secures $9,000 with the brokerage firm and then submits an order to “Sell to open” 1 put at $90.00, immediately bringing in $110 in the brokerage account at the mid-price. As a result, the investor has 31 days to wait to see if MS stock will fall to $90.00 per share and the $9,000 is exercised to automatically purchase 100 shares at $90.00. If the stock doesn't fall to that level, the investor has kept all of the $110 and does not have to purchase the stock. Moreover, his breakeven price is lower at $88.90 per share ($90-$1.10), or $9.29 per share below today's price. That provides 9.46% of downside protection before the put can be exercised.

In addition, some enterprising investors may want to implement a Jade Lizard strategy to make more income. I have described this in several recent articles, including this one on Jan. 15, 2023, concerning EQT Corp (EQT). 

This means the investor keeps the short put trade, but also puts on a short call that is out-of-the-money, as well as a higher strike price long call purchase. That allows the investor to make money as MS stock rises over today's price. This is because the short-put investor cannot make an unrealized gain if MS stock rises.

For example, in this case, if the investor were to short the Feb. 17 $105 strike call for $1.73 per call (after buying 100 shares at $98.19), and then also buy the $110 call for 46 cents, the net credit will be $1.27. So, combined with the $1.10 in short put income, the total income in this Jade Lizard strategy is $2.37 per contract. That means that the stock could rise to $107.37 before there is any potential loss (i.e., $105+2.37 in income). But if the stock closes at $104, by Feb 17, the total gain will be $5.81+2.37 or $8.18 per contract or $818 on the $9,819 investment. That works out to a profitable gain of 8.33% in one month or 100% on an annualized basis.

This shows that the huge spike in MS stock provides good income plays, especially since its options prices are skewed heavily toward puts.

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