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Wednesday, October 10, 2012 - 16:00
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Wednesday, October 10, 2012 - 16:01
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Wednesday, October 10, 2012 - 16:00

Earn 1% a Week in Trading Profits While Investors Flee This Stock

Wednesday, October 10, 2012 4:00 PM

Last week, Hewlett-Packard (NYSE: HPQ) announced a far steeper-than-expected drop in 2013 profit, which sent the stock to a nine-year low.

You may be asking yourself whether a company that was founded in 1939 and is expected to report more than $100 billion in revenue and nearly $7 billion in operating profits next year is worth buying at a price-to-earnings (P/E) ratio of 4. But that is probably a decision best left to value investors for now. As traders, there is a safer way to make money from Hewlett-Packard.

In a few years, we may see that Hewlett-Packard has become the next IBM (NYSE: IBM), another tech giant given up for dead by investors in the early 1990s. Instead of continuing to fall, the price of IBM formed a base over several years and then delivered a gain of more than 1,200% in six years.

Unfortunately, there is no way to know if that will be the case with Hewlett-Packard, or if the stock will be another Xerox (NYSE: XRX), which fell on hard times and never recovered.

The long-term chart of Hewlett-Packard shows a steep decline, just like IBM and Xerox showed, and the fundamentals could be appealing to value investors. Hewlett-Packard is selling for less than the company's book value and has sufficient cash flow to maintain its dividend, pay down its debt and meet its operating needs.

Despite the positives, the chances of a large short-term gain in the stock price seem remote. It seems equally remote that there is much downside left in the stock.

Analysts have lowered their earnings estimates but still expect the company to report earnings per share of $2.10 to $2.30 next year after accounting charges. Operating earnings should come in at about $3.40 to $3.60 a share.

Earnings like that have a long-term value and eventually the stock should recover. With a P/E ratio of 10, Hewlett-Packard could be worth $35 a share in time.

This stock is set up for an income trade for traders willing to sell puts. Hewlett-Packard closed last week at $14.73, down 14.36%. There likely won't be any more news out before earnings, which are scheduled to be announced on Nov. 20, a few days after the November options expire on Nov. 16.

After a big drop, traders generally expect a dead cat bounce in a stock. That makes the November $13 puts look like a low-risk sell. The strike price is about 11% below current prices, and it would be unusual to see a decline of that much following a week like we just had.

These options are currently trading around 21 cents, and if they expire worthless, traders will get a return of about 8% on a fully margined position in about six weeks. If Hewlett-Packard falls below $13, we would own the stock at a price of $12.79 ($13 strike minus $0.21 premium collected), or 3.7 times next year's operating earnings. The stock would then offer a dividend yield of 4.1%, making it a strong income investment on its own. But I doubt the stock will fall that low and we will have to be happy with earning a little more than 1% a week by selling puts on Hewlett-Packard.

Action to Take --> Sell Hewlett-Packard Nov 13 Puts at 30 cents or less. Do not use a stop-loss. If Hewlett-Packard closes above $13 at expiration, the puts will expire worthless and you could realize a 100% profit. If Hewlett-Packard closes below that price, you will buy Hewlett-Packard at a low price and have a chance to enjoy long-term gains in this company.

This article originally appeared on TradingAuthority.com:

Earn 1% a Week in Trading Profits While Investors Flee This Stock

Amber Hestla does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.