Trades

HP Disappoints, While Traders Profit

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The tech industry is incredibly unique. While most industries have some new and some old companies, the difference between them is never quite as large as in technology stocks.

You have everything from Uber to IBM, Facebook to Intel. But in all of these cases, older companies try to keep up. IBM sees itself as an artificial intelligence and supercomputer innovator. Intel does its best to build out its cloud and chips to compete with the likes of AMD and NVIDIA. And then there’s HP Inc. (NYSE:HPQ).

HP, known for its notebooks and printers, has remained a large enough player in hardware and customer products. While it remains a sizeable competitor in the PC business, its real money has always come from its printing division.

Unfortunately, as you can probably already guess, printing and demand for printers, specifically, isn’t as large as it once was.

The move to digital has hit HP as hard as it did to Xerox back in the day. Remember them? They are still around, but only as a pale reminder of what technology companies used to look like.

HP, however, has had one advantage. Margins in the printing industry have always been extraordinary.

If you’ve ever had to go out and pick up replacement ink cartridges for your printer, you know what I’m talking about. These things seem like a giant rip off. But if you need something printed, you have to open your wallet.

Well, with increased competition – and generic brands mostly from China – HP’s grip on even this segment has been slipping. Less demand and weakening market position don’t make for a growing company.

Still, the company has been able to keep its revenues flat, despite slowly falling printing numbers. Investors have significantly discounted its share price, however. They currently trade for just 6.1 times earnings.

So, some changes were long overdue… and now the company is doing them.

Its former CEO is stepping down – although for personal reasons – and a new crowd at the helm is set to take over. With this new leadership, HP announced a major restructuring.

The move was announced Thursday evening.

Instead of sitting back and watching competitors eat up market share for its high-margin ink business, HP is going to begin selling locked and unlocked versions of its printers. Locked printers will be cheaper, but require HP ink. Meaning it will retain 100% of its ink business in exchange for less money for its hardware. Unlocked versions cost more, but can use outside-branded ink.

On top of that, the company is cutting up to 9,000 jobs, or 15% of its workforce. This, according to the company’s presentation, will save $1 billion by next year.

Now, this is certainly a bold new strategy and might work out in the long run… somewhat. But investors – and more specifically analysts – were less than taken with it.

On Friday, HP’s shares fell nearly 10% following this strategy’s announcement. Initial reactions included every kind of polite disagreement, from “turbulence ahead” to “investors will view HP’s capitulation as net-negative.”

Analysts argue that this restructuring plan was “largely unavoidable” but that it won’t necessarily work. The cost cutting scheme seems to be the only thing they agreed on, noting that it is needed, but also that it “may not be sustainable.”

Unfortunately, they may be right. And investors are already heeding this advice, sending shares tumbling below all of HPQ’s support levels:

Screen Shot 2019-10-07 at 11.52.13 AM.png

Shares are in a freefall. And they may have further to go. However, their fall has left the company’s price tag extremely cheap compared to competitors. Moreover, the company’s dividend now looks even larger than before.

At its new sub-$17 price level, HPQ now carries a 3.5% dividend yield… top in the industry. The cost savings, according to the company, will be used to pay for that yield, as well as continued share buybacks.

Now, really, shares of HPQ could go anywhere from here. If the analysts can continue to convince investors of how poor this restructuring plan is, there’s no floor left to find support for falling price. However, if investors take on this risk in favor of a relatively undervalued company with a large dividend, shares could easily bounce right back.

In either case, the one thing we do know is that shares aren’t going to sit still here. Fortunately, there’s a strategy for that. Instead of betting on the direction they head from here, you can trade on the size of the move (in either direction).

Let’s take a look at that strategy now…

A Strategy For Short Term Volatility

A long straddle is a type of options trade that profits from short term volatility. It is, in essence, a directionless trade. Meaning if shares go up, it does well. If shares go down, it also does well.

The only time a long straddle earns a trader a loss is if shares simply don’t move at all. For HPQ, that’s not likely to happen.

You can see how this strategy works here:

Long-Straddle-Option-Trading-Example-2

Source: TheOptionBros

To enter a long straddle, the trader needs to buy both a put option and a call option with the same strike price (one that’s at-the-money). Since shares are trading just a bit below $17, that’s the price point a trader would use for HPQ right now.

Let’s look at a specific trade to see just what it might look like.

A Specific Trade on HPQ

Right now, a trader could buy a November 15 $17 call for $0.49 per share and a November 16 $17 put for $0.85 per share for a total cost of $1.34 per share. Since each option is worth 100 shares of HPQ, that’s a net debit of $134 to the trader’s account.

Now, that’s the total amount at risk. If shares don’t move a hair above or below $17 between now and November 15, this trade would theoretically lose $134. Though, as you can guess, that’s extremely unlikely.

Instead, either momentum traders or value investors will gain control, sending shares either spiraling further or rebounding hard.

In either case, the further away from $17 those shares head, the higher the profit. And those profits are virtually unlimited. There’s no cap to how much the trader can make. Though, for this trade to enter profit territory, it does take some significant movement.

To find the breakeven/profit point for this trade, find the difference in strike price to cost. For the puts to become profitable, subtract the cost from the strike price ($17 – $1.34 = $15.66). For the calls to, add the cost to the strike ($17 + $1.34 = $18.34). So, anything outside the range of $15.66 – $18.34 is pure profits.

That might sound like a large move. But considering that represents just a 7.9% jump or decline (either works) in HPQ’s price by November 15, that’s not much. Just on Friday, shares dipped nearly 10%. Several more of those large swings are now definitely on the table. And if any carry HPQ far from $17 per share, remember, those profits are nearly limitless.

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