Unusual Options Volume in Hewlett Packard Enterprise Co Ahead of Earnings Shows Investors Bullish on HPE

Today's heavy volume in out-of-the-money (OTM) put and call options in Hewlett Packard Enterprise Co. (HPE) shows investors are bullish ahead of its fiscal Q3 earnings release tomorrow. Moreover, analysts have higher HPE price targets.

HPE is down today in midday trading at $50.87, but the stock is higher than a recent low at the end of July ($44.44 on July 29). However, it's still below a recent peak of $59.82 on Aug. 13.

That's interesting because some large investor likely shorted OTM puts and calls in heavy volume at strike prices near these two peaks.

This can be seen in Barchart's Unusual Stock Options Activity Report today. It shows unusually heavy volume in $45.00 strike put contracts expiring Sept. 4, as well as $59.00 call options on the same day.

These strike prices are -11.5% lower (puts) and +16% higher (calls) than today's price, so they are deep out-of-the-money, with just 3 days to expiry on Sept. 4.

The point is that the investors who likely initiated these trades are happy to collect income from shorting these puts. They feel strongly that HPE stock won't move these distances in just 3 days. 

In essence, it's a somewhat bullish move. For example, the short-put trade provides a 3-day yield of 1.2667% (i.e., $0.57/$45.00), and the short-call play yields (on a covered call basis) a 1.2558% yield (i.e., $0.64/$50.87).

Those are attractive expected returns, especially for 3 days. And no wonder, since analysts are very positive on HPE.

Strong Earnings Outlook

HPE is a direct beneficiary of heavy capex spending by hyperscalers on AI and cloud data operations. Revenue is forecast to rise over 30.7% to $11.94 billion this quarter ending July 31, up from $9.14 billion a year ago. 

Last quarter it made $10.96 billion in revenue, so any sales number over $11.96 billion will be unexpected.

Moreover, analysts project 93 cents in earnings per share (EPS) this quarter, compared to 44 cents last year and 79 cents per share last quarter. 

More importantly, HPE is now generating strong free cash flow (FCF). Last quarter it generated $0.9 billion in FCF, representing 7.75% of sales, according to Stock Analysis. And over the prior 12 months, FCF was $3.989 billion, or 10.28% of trailing 12-month (TTM) sales.

So, any FCF higher than these two figures, especially the TTM margin, will likely push HPE stock higher, and vice versa.

HPE Price Targets

Analysts have significantly higher price targets. For example, Yahoo! Finance reports the average of 22 analysts is $65.35, or +28.5% higher. Similarly, Barchart's mean survey PT is $68.39, and AnaChart's survey of 16 analysts is an average of $66.44.

This is likely due to HPE's strong free cash flow (FCF) outlook. For example, analysts project revenue this year ending Oct. 31 will be $45.05 billion (vs. $34.3 billion last year), and $50.34 billion next year.

So, if HPE averages a 10% FCF margin over the next year, it could generate $5.034 billion in FCF. That's more than $1 billion higher than its TTM FCF of $3.989 billion and could push HPE stock higher.

For example, using a 5.5% FCF yield metric, HPE's fair value would be: 

  $5.034b / 0.055 = $91.53 billion

That's 35.6% higher than today's market cap of $67.48 billion, according to Yahoo! Finance. That means the price target is $68.97 per share ($50.87 x 1.356). This is why analysts are so bullish on HPE stock.

Conclusion

And it may account for why investors are busy today shorting deep out-of-the-money puts and calls in HPE stock. They are happy to collect the premiums for these very low-delta trades that expire after tomorrow's earnings release.

In fact, this income could fund the purchase of call options that expire in later periods. That is one reason why some of these investors may be shorting OTM HPE puts and calls.