Potential Option Strategies for Drama-Ridden Hewlett-Packard (NYSE:HPQ)

Hewlett-Packard (HPQ) option strategies It has certainly been exciting in Hewlett-Packard HPQ over the last couple of days as a series of increasingly bizarre events has unfolded. Just after the close on Friday, the computer company’s Chairman and CEO Mark Hurd resigned amid charges of sexual harassment. Later, the former contractor who made this claim against Hurd said she was “surprised and saddened” that the executive was forced to resign his post.

Amid all of this controversy, the company announced rather positive preliminary third-quarter guidance. HPQ said it expects to earn $1.08 in the reporting period, compared with the consensus view of $1.07.

HPQ shares gapped 6% lower out of the gate on Monday on heavy volume and were off more than 8% at their lowest point. Now investors must ask … is this merely an overreaction, presenting a low point at which to enter a new position, or is the leadership shakeup a sign of more downside to come?

For the bulls and the bears out there, we’ve outlined two potential option strategies – a long call spread and a put tree. Note that these are not buy/sell/hold recommendations, merely examples of various strategies for educational purposes. The prices are taken as of Monday’s close, when HPQ shares were trading at $42.60, down $3.70 on the day (and not far from their intraday low). Learn more about long call spreads at our free webinar at 4:30 p.m. (Eastern Time) today. I’ll be getting some help from OptionsHouse contributor Jared Levy to discuss this strategy in detail. Register for the event from our events page.

Moderately Bullish Option Strategy: Long Call Spread

Investors who think HPQ may snap back from this weakness could consider a long call spread, also referred to as a bull call spread. The September 40/45 call spread can be purchased for a net debit of $2.70 (by buying the 40-strike call and selling the 45 call). This is a limited risk, limited reward strategy. The maximum the investor can lose, no matter how low HPQ might plunge, is capped at 100% of this premium (plus commissions).

On the flip side, the spread can make as much as $2.30 (the difference in strikes minus the premium paid) if HPQ manages to muscle back above $45 by expiration on September 17. Breakeven for this spread, at expiration, is $42.70. This is a moderately bullish spread as it requires only a slight move higher in the shares by expiration to put the spread in profitable territory.

Hewlett-Packard (HPQ) bull call spread

Moderately Bearish Option Strategy: Put Tree

Those who expect continued downside in HPQ, but limited after yesterday’s pullback, could consider the “put tree” strategy. This is similar to a ratio put spread but is modified because the trader buys one near-the-money put and sells two different lower strike out-of-the-money puts. For example, an investor could open the November 42/40/38 put tree by buying the November 42 put, selling the November 40 put, and selling the November 38 put for a combined net credit of 20 cents.

The maximum potential gain, which occurs if HPQ is between 38 and 40 when the options expire, is $2.20, or the difference between the long put and the higher-strike short put, plus the credit collected). If HPQ is trading anywhere above the 42 strike at expiration, the investor simply keeps the net credit of 20 cents.

Below the breakeven price of $35.80 (the lowest-strike put minus the maximum gain), losses are unlimited down to zero but capped at $35.80 should the stock lose all of its value. This risk is due to the naked short 38-strike put, which obligates the trader to purchase HPQ stock if the shares fall below $38. The long 42 put and the short 40 put essentially “cover” one another.

Profit/Loss of Hewlett-Packard (HPQ) put tree