Stock Options To The Rescue! Hewlett-Packard (HPQ)

| May 30, 2012 | 0 Comments

Today we’re going to look at a stock replacement strategy on Hewlett-Packard.  It allows you to reduce your risk and gives you upside potential.

Here’s what happened…

Hewlett-Packard (HPQ) shares opened up more than 7% today after reporting earnings after the market closed yesterday.  In their latest quarter HPQ beat analyst’s earnings estimates.  And they announced plans to restructure the company and increased full year earnings guidance.

Here’s the deal…

The tech giant reported quarterly earnings of $0.98 per share.  Earnings we’re more than 7% better than $0.91 analysts were expecting.  And revenue fell 3% from last year to $30.7 billion.

However, HPQ’s restructuring plans stole the show.  The company expects to save them $3.0 to $3.5 billion per year by firing 27,000 employees.

HPQ’s CEO Meg Whitman, believes the changes they are implementing today will return the company to the path of long term growth.

Here’s the kicker…

On Tuesday, fellow PC maker, Dell (DELL), reported a disastrous quarter.  Dell’s horrible quarter pulled down HPQ’s stock ahead of their quarterly earnings report on Wednesday.

Investors who bought HPQ as it sold off due to Dell’s earnings were handsomely rewarded today.  The stock popped more than 7%. Unfortunately, HPQ has begun to give back some of those gains throughout the trading day.

Obviously, if you bought HPQ ahead of earnings you we’re expecting some positive news from them.  And we got it.  HPQ is entering into a massive restructuring.

But there’s still a lot of uncertainty around the success of their restructuring plan.

Instead of hanging onto the stock, take a look at replacing your stock holdings with a call option.

Here’s what to do now…

Let’s assume you bought 100 shares of HPQ at $21 before earnings.  It’s currently trading at $21.65.  So, you’re sitting on a small 3% gain.

Selling HPQ and buying the HPQ November $24 call option for $1.15 will reduce your risk and give you upside potential if HPQ’s restructuring fuels a rally over the next few months.

The November option gives us almost two full quarterly earnings cycles for investors to evaluate how Meg Whitman’s plan is taking shape.

If investors buy into HPQ’s plan, the stock could easily hit $30 by the time our options expire.  However, investors will likely cut and run if the restructuring doesn’t get off to a good start in the next few months.

Don’t forget, HPQ has fallen 60% from its 2010 high of $55.  And it hasn’t shown any signs of pulling out its freefall.  If there’s even a hint that the restructuring won’t fuel the promised increase in profitability, the stock could easily plummet to around $15 or even lower.

If you hold onto the stock your $2,100 investment it could be worth $3,000.  Or it could be worth $1,500 or less.  In other words you’re taking on $600 of risk in order to make $900.  And that’s just too much risk in my book.

The call option costs you $115.  If HPQ’s restructuring flops, that’s the maximum you can lose.  However, if HPQ soars to $30, the option will be worth $600.  That’s potential profits of $485 with only $115 worth of risk.  Now that’s a risk/reward profile I can live with.

As you can see, replacing your HPQ stock holdings with a call option will help you reduce your risk and still give you the upside potential you’re looking for.

Good Investing,

Corey Williams

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Category: Options Trading

About the Author ()

Corey Williams is the editor of Sector ETF Trader, an investment advisory service focused on profiting from ETFs and the economic cycle. Under Corey’s leadership, the Sector ETF Trader has become one of the most popular and successful ETF advisories around. In addition to his groundbreaking service, Corey is the lead contributor to ETF Trading Research, where he shares his insights about ETFs and financial markets on a daily basis. He’s also a regular contributor to the Dynamic Wealth Report and the editor of one the hottest option trading services around – Elite Option Trader.

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