A large out-of-the-money call option purchase in The Charles Schwab Corp (SCHW) stock shows that one institutional investor has a bullish outlook for the financial services company. The trade was reported today in Barchart’s Unusual Stock Options Activity Report.
It showed that a large investor had sold 19,600 call options at the $80.00 per share strike price for expiration on or before May 19. It turns out that this number of call options is over 26x the existing 748 contracts outstanding. That shows that they are very confident that SCHW stock might rise to that level or less in the next 65 days.
The reason is that this strike price ($80) is over 38.5% higher than today’s price of $57.73 per share. This would not have such a tempting premium level at 89 cents per call option. For example, the investor who shorted these calls has the ability to make 1.54% (i.e., $0.89/$57.73).
That shows that the investor who likely had to purchase the underlying shares as a covered call investment (or may already own the shares) is happy to let the stock rise 38.5% in the next two months. In effect, they will make a 40% return (i.e., 38.5% +1.54%) if that happens.
This trade can be seen in the Barchart Unusual Stock Options Activity Report above. In this case, it means that the investor who purchased 1,960,000 shares (i.e., 19,600 calls x 100 shares) at $57.73 for $113.15 million, immediately received $1.744 million (i.e., $0.89 x 19,600 x 100). I highly suspect that the investor already held these shares, and they possibly may have a higher cost in those shares. This is because the stock is down significantly (-27.8%) from $80 where it closed on Feb. 22.
Why This Trade Makes Sense
As it stands, The Charles Schwab Corp stock is actually not that expensive. Analysts project that it will make $4.20 earnings per share (EPS) this year, giving it a multiple of 13.7x. Moreover, the company pays a small dividend of $1.00 per share, giving SCHW stock a 1.73% dividend yield at today’s price.
Both of these valuations show it is cheaper than its five-year historical averages. For example, Morningstar indicates that the average forward multiple has been 19x in the last 5 years. That means its 13.7x multiple today is at a 27.8% discount to this historical average. At this level, the stock would be worth $79.80 per share (i.e., 19 x $4.20).
Similarly, Morningstar says that the average dividend yield in the last five years has been 1.21%. That is lower than today’s 1.73% yield, and implies that the stock could be worth $82.64 per share (i.e., $1.00 / 0.0121 = $82.64).
So, on average, using these two metrics, the stock is worth $81.22 per share. That shows why the investor is comfortable shorting a call option at $80.00 for the next two months. Moreover, even if the stock were to be worth just 85% of that valuation, it would still be worth $69.00 per share. That implies at least a 19.5% gain over today’s price. Moreover, with the 1.54% call yield, the investor would make a 21% return in just 65 days or less, and would not have to give up the shares since the strike price is $80.00.
So, as we have shown in other articles on unusual options activity, you can see why an investor today is comfortable selling an out-of-the-money covered call at $80 and collecting the high premium.
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On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.