Trade Update $HPQ – Pinball

by Enis December 20, 2013 1:46 pm • Commentary

As we discussed earlier today, HPQ had a high risk of pinning the $28 strike.  It looks likely to do so as the day has progressed, so we are going to take the trade off here at $0.08 to avoid the pin risk and call it a day on this one.

Action:  HPQ ($27.97) Sold to close Dec20th 28 put at $0.08 for a $1.02 loss

Considering Our Options $HPQ – The Risk of the Pin, December 20, 2013:

HPQ has been quite a mover since its earnings gap higher at the end of November.  This was a trade that we could have exited on a couple occasions in the last 2 weeks for a profit, but held on as the stock held below 28.  Well, the Fed announcement sent the stock zooming higher to near the 28 long strike, and we should have closed this position earlier this week for a better loss at a minimum.

In any case, I wanted to take the opportunity to use this mistake as a teaching lesson for today’s trading session on expiry.

We currently own the Dec20th 28/25/22 put fly, for which we paid 1.10 last month.  At this point, the trade is essentially just a long Dec20th 28 put.  Since it is expiry today, if the stock closes above 28, our put will expire worthless.

At this point, the stock is trading at 27.95, so the intrinsic value of the put is 5 cents.  The put is bid around 0.14, which means the option has a “time” value of 9 cents.  That’s due to the time between now and the close today, almost 5 hours, in which the stock can still move quite a bit.

Our decision at this point is to take the 0.14 in premium and call it a day, or hold out for a potentially better price, at the risk of the trade expiring worthless.

I am going to hold on to the put since HPQ is up for 5 straight days, and so I view the odds of a down day as greater than normal, but for those who want to salvage some premium and don’t want to take the risk of the trade expiring worthless, it might be worth hitting the existing bid.

One last point – if HPQ remains around $28 between now and the close, the time value will gradually decrease on the option.  In that case, the longer you wait, the less the option will be worth, if the stock remains close to the $28 level.  You are paying for the option to wait, hence the gradual decay.

Original Post Nov 26th, 2013:  New Trade $HPQ – Printer Jam

We previewed HPQ’s fiscal Q4 earnings release yesterday morning.  Our key takeaway from that preview:

HPQ is one of the best performing hardware stocks of 2013.  That strong outperformance is largely a function of dismal performance in 2010, 2011, and 2012. With the stock’s P/E close to 10, combined with the secular headwinds that the company faces, a range bound situation between $20 and $28 over the next 3-6 months seems the most likely outcome.

While we are skeptical about the company’s prospects in the long-run given the lack of investment, the short-run picture looks more mixed.  HPQ has been locked in a bull/bear battle for the past 6 months, with no clear winner.  Bulls continue to tout the cheap valuation argument, while bears view the valuation as distorted by accounting gimmicks, and the business prospects as poor to very poor.

Add it all up, and here’s our trade ahead of the earnings report after the close:

TRADE:  HPQ ($25.23) Buy Dec21st 28/25/22 Put Fly for $1.10
  • Buy 1 Dec21st 28 Put for 3.20
  • Sell 2 Dec21st 25 Puts at 1.17
  • Buy 1 Dec21st 22 Put for 0.24

Break-Even on Dec21st Expiration:

  • Profits of up to 1.90 between 23.10 and 26.90, with max profit of 1.90 at 25
  • Losses of up to 1.10 between 22 and 23.10 and between 26.90 and 28, with max loss of 1.10 below 22 or above 28

Trade Rationale:

HPQ has traded between 20 and 28 for the past 6 months.  HPQ’s strong guidance for 2014 in early October was the catalyst for the stock’s most recent, 1 month bounce from 20 to 26.50.  Since that news is already in the stock, the novelty of today’s earnings report is reduced.  While that is reflected in the lower-than-normal implied move in the options market for HPQ earnings (7.5% vs. over 10% moves in each of the past 4 quarters), we view the likelihood of a break higher or lower as greatly reduced nonetheless.

The range trade centered around 25 is based on the August high of $27.77, and the rising 50 day and 200 day moving averages in the $23 – $23.50 area.  The main risk that we see is on revised guidance materially different from 6 weeks ago (either better or worse).  While we don’t expect that given Meg Whitman’s generally conservative stewardship, that could put this trade in the losing column quite quickly.