HP Inc. Has Unusual Put Option Activity - A 7.4% Short-Put Yield - But Is It a Trap?

Investors are trading out-of-the-money HP Inc. (HPQ) put options expiring in 2 months in heavy volume. That allows short-put HPQ investors to earn a 7.4% yield, ahead of earnings later this month. But could this be a yield trap?

HPQ is trading at $29.11 today, just off its recent peak of $30.05 last week (Aug. 7). HP, Inc., which makes computers, printers, and other computer hardware, is set to report its Q2 earnings in two weeks, on Aug. 26, after the market closes. 

HPQ's recent rise could be a catalyst for heavy put option activity ahead of earnings. For example, the chart above shows that HPQ has had a volatile run since its last earnings release. 

And, it's not uncommon for stocks to rise ahead of earnings, only to dip thereafter. That's a sort of “sell on the news” effect.

The high put option volume can be seen in today's Barchart Unusual Stock Options Activity Report. Buyers of these puts may be betting that earnings will disappoint and HPQ will fall thereafter.

However, the report shows that the expiry period for this heavy put volume is over two months from now, on Oct. 16.

The Barchart report shows that over 2,000 puts have traded at the $28.00 strike price, which is over 4% below today's trading price. That is over 10x the normal activity, i.e., prior number of contracts outstanding at that strike price and expiry period.

Moreover, look at the premium. It is very high at $2.08 at the midpoint.

That means that put buyers are paying a hefty price for this bet that HPQ will fall. For example, sellers of this put can earn a 7.429% yield (i.e., $2.08/$28.00 = 0.07429).

That is a high yield, working out to 3.377% per month, and, if it can be repeated, 40.52% on an annualized expected return.

Moreover, consider this. Short-sellers actually will have a lower buy-in point if HPQ drops to $28.00. Their potential breakeven buy-in is:

  $28.00 - $2.08  = $25.92

That's almost 11% below today's price. In other words, a lot of bad news is already discounted in this price. It means value investors can set a lower buy-in shorting these puts.

But could this be a yield trap?

What Is HPQ's Price Target?

Analysts have an average price target of $22.98 according to Yahoo! Finance, and $24.66 according to Barchart's survey. Moreover, AnaChart's survey, which tends to include more recent write-ups from analysts, is in the middle at $23.17.

Based on this, analysts expect HPQ to drop about $6.00. That's 20% below today's price.

One reason for this could be the high prices for memory and storage chips. That may be dampening demand for personal computers and printers.

As a result, analysts are worried that revenue and earnings could disappoint. For example, analysts are expecting just 2.94% revenue growth this quarter ending July 31, according to Yahoo! Finance.

Moreover, earnings per share (EPS) forecasts are just 66 cents, compared to 75 cents EPS last year and 86 cents last quarter. Analysts expect lower earnings.

So, if that happens, shorting these puts is not a good play. The breakeven price of $25.92 will still be higher than the $23.17 price target.

Summary and Conclusion

As a result, investors should be careful here. The high yield could be a trap. 

It might make sense to see if there is any weakness after the earnings report and then short out-of-the-money (OTM) puts.

After all, it tends to work better to short puts when investors are very negative on a stock - i.e., when it is at a trough point.

Therefore, be careful in shorting these puts. The high yield could be a trap. Prudent investors will want to wait to do this until after Aug. 26.