Huge Unusual Put Options Volume in Merck - Is MRK Stock Overvalued?

A Barchart report shows that despite recent strong Q2 results and a 10% spike in Merck & Co., Inc. (MRK) stock today, an unusually large volume of put options has traded at a much lower strike price. Is MRK stock overvalued?

MRK is up $14.66 today at $149.83 (i.e., +10.85%) in midday trading. The stock has been moving higher over the past three months, including today's 10% spike, as can be seen in the chart below.

The company released its Q2 earnings on Aug. 4 with strong revenue growth driven by its oncology drug portfolio. It just announced success in a stage IV melanoma drug combination trial with Moderna (MRNA), which may account for today's spike.

That's why today's huge put option volume is somewhat puzzling. Why are investors betting that MRK could fall? Do investors see MRK at a peak? Or was this huge option volume initiated by short sellers, taking advantage of MRK's high put option premiums?

Let's look at the trade.

Unusual Put Option Volume in MRK

This can be seen in Barchart's Unusual Stock Options Activity Report today. It shows that over 7,000 put contracts have traded at the $135.00 strike price, almost 10% below today's price.

The expiry period is 93 days away (i.e., three months) on November 20. This volume is almost 70 times the prior number of put contracts outstanding.

As a result, I suspect that investors may have been taking advantage of the high put premium, which was $4.10 in the Barchart report, and is the existing midpoint premium.

That means these investors would have made a 3% yield for the next three months (i.e., $4.10/$135.00 = 0.03037 = 3.037% short-put yield).

Moreover, this means short-sellers have a much lower potential buy-in point: $135.00 - $4.10 = $130.09. That provides good downside protection, i.e., -12.6% below today's price.

So, is MRK overvalued here, as put buyers seem to believe? Let's look further into its valuation.

Analysts' Forecasts and Price Targets

Analysts see MRK as overvalued, since the average price target (PT) for 28 analysts surveyed by Yahoo! Finance is $137.73, and Barchart's survey PT is $138.70. AnaChart's survey shows that 14 analysts have a much lower average PT of $126.61.

After all, earnings per share (EPS) this year are expected to drop significantly from $8.98 last year to just $2.75 this year. That means the stock is on a very high expected price/earnings (P/E) of over 54x.

However, this thinking may be wrong, and MRK might not be so overvalued. 

Valuation Ranges

For example, Merck's 2026 EPS estimates are depressed by one-time acquisition charges of $5.93 relating to two acquisitions (Cidara Therapeutics, -$3.62, and Terns Pharmaceutical, -$2.31). These are one-time hits. Without these, normalized EPS would be $8.68.

Moreover, analysts are forecasting $9.56 EPS for next year. That puts MRK on a forward P/E of just 15.67x. That is well below its average forward P/E of 19.69x according to Seeking Alpha.

As a result, a revised 2027 price target could be as high as $188.24 (i.e., $9.56 x 19.69), +25.6% higher.

However, Merck is likely to announce a dividend per share (DPS) hike next quarter, as it has done for the past 15 years. If it rises to $3.63 (up from $3.24), using its historical 2.94% yield average, the price target is $123.47:

  $3.24 / 0.0294 = $123.47

That is 17.6% below today's price. As a result, the valuation range is between $123.47 and $188.24, or $155.86. That's only 4% higher, at the midpoint.

Conclusion

The bottom line is that shorting puts with a $130.09 breakeven point might not be a bad play. It has a potential expected return (ER) of 19.8% ($155.86/$130.09 -1) over the next year. Moreover, the investor makes a 3% yield over the next three months, waiting to see if MRK will drop to $135.00.

However, investors should be careful to understand this play could result in an unrealized loss, especially if MRK falls below the $130 breakeven point and stays there.