Analysts have hiked price targets for Palo Alto Networks (PANW) stock. In a prior article, I showed that a short-put PANW play works well. Another play for investors with limited capital is a PANW bull put credit spread. This play offers high expected returns, although risks are higher as well.
PANW closed at $374.74 on Friday. It's down from a recent peak of $393.30 (Sept. 23), but well up from its Sept. 11 low of $330.65. That was after the cybersecurity company's Sept. 1 fiscal Q4 earnings release.
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PANW stock - last 3 months - Barchart - Sept. 25 I showed in a Sept. 4 Barchart article ("Palo Alto Networks Delivers Strong FCF Margins - Is PANW Stock Set to Rise?") that PANW could be worth $461 per share. That was based on its strong free cash flow (FCF).
Moreover, since then, other analysts have raised their price targets (PTs). For example, Yahoo! Finance's survey of 55 analysts now has an average PT of $395.70, up from $390.50 as seen in my Sept. 4 article.
Also, Barchart's mean survey PT is $396.97, up from $391.40.
But, look at the chart above. It seems to show that PANW has treaded water over the last two months. So, there's no guarantee PANW will rise to its PTs. This makes it ideal for short-put plays and put credit spreads.
Short-Put PANW Plays
In the Sept. 4 Barchart article, I discussed selling short the $310 strike put option expiring Oct. 9. The premium received was $9.23 x100, or $923 for $31,000 in posted collateral. That worked out to an expected one-month yield of 2.977%.
As of Friday, the premium had sunk to $0.47 at the midpoint. So, the investor has now earned most of the potential income. It makes sense to roll this play over.
For example, the Oct. 30 expiry period (32 days away) shows that the $345.00 strike put option has a midpoint premium of $10.43. That works out to a one-month expected yield of 3.023%, similar to last month.
PANW puts expiring Oct. 30 - Barchart - Sept. 25, 2026 However, to do this play, the investor would need to “Buy to Close” for $45 the $310 put, in order to free up the $31K in collateral. Then the investor would “Sell to Open” 1 put at $345, collecting $1,043 ($10.43 x100), but posting $34.5K in collateral ($3.5K more capital).
So, the net income collected is $1,043 - $45 = $998. That works out to a net yield of 2.89% (i.e., $998/$34,500), similar to last month. Moreover, the past two months have yielded $1,921, or $19.21 per share.
The worst that can happen here is that the investor's account is assigned to buy 100 shares at $345.00. But after the past two months' income, the net breakeven would be:
$34,500 -$1,921 = $32,579, or $325.79 per share
That provides 13% downside protection from today's price, even on a worst-case basis. However, investors have to post $34.5K in cash collateral to do this play. One way around this, with higher risk, is to do a put credit spread.
PANW Put Credit Spread Play - High Risk, High Return
To lower the collateral requirement, the investor buys one put at the $335.00 strike price. Since the premium is $6.18, the net credit collected is:
$1,043 - $618 = $425 net credit
However, the investor only has to post $1,000 in collateral since the put purchase covers all potential losses if PANW drops below $335.00:
$34,500 (short) - $33,500 (long) = $1,000 short collateral required
As a result, as long as PANW stays over $345.00-$4.25, or $340.75, the investor has the potential to make a huge return:
$425 / ($1,000 - $425) = $425/$575 = 73.9%
However, if PANW drops below $340.75, i.e., 9.07% lower than today's price, the investor stands to lose up to $1,000 in collateral.
As a result, this play is only for investors willing to take on more risk of loss of collateral (even after the net credit spread). However, even if this happens, the investor can sell the lower leg and accept assignment (if they have the $34.5K in collateral).
The bottom line is that if PANW keeps treading water, as it has done in the last two months, and, given its higher PTs, this is an ideal play for speculative investors.
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.
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