What Can You Do With Hewlett Packard Shares? Trade The Range on Astini News

Hewlett Packard (HPQ) has been in the news a lot. Specifically, in the face of a disappointing earnings announcement, HPQ announced that it is considering selling its PC business and buying software company Autonomy. The market did not react well to this news, and the HPQ stock fell by over 25% to a low of $22.75.

Prior to this announcement HPQ was thought by many to already be a deep value stock. In full disclosure, this investor was one of those people. I was not overly bullish on HPQ because:

• Its consumer business seemed to be becoming commoditized.
• HPQ's strategy seems to be "like IBM (IBM) and Oracle (ORCL)." Being third to the party is not an overly inspiring strategy.
• Senior management instability.
• Diverse cultures of its past acquisitions like EDS take time to integrate.

However, it seemed these issues were already factored into the low P/E nature of the stock price, and there was minimal risk of further downside risk. Looks like that was wrong. I had established a two lot position at an average cost per share of $35.60 with the plan of trading around those shares for modest gains. Not a good entry price. Now I and many other investors are faced with the question of what to do with the position.

One approach is to just sell, and remove the pain an investor feels when sitting on a loss. At the other extreme, there is a desire to believe the stock will come back. Hence there is a tendency to wait and hope to make your money back. Unfortunately, these two alternatives sound like panic selling and anchoring to your cost, respectively. These are often considered the most common mistakes investors can make. A third strategy of using options to trade around the core position based on the following thesis is another alternative.

Trading Thesis

• Valuation Support - HPQ is trading with a P/E of around 6. That leads many to feel that it is low priced and a reason to buy. However, to determine a valuation it seems like there is a need to back out the cash on hand, estimate the value the sale of the PC business might generate, add in the cost of its recent acquisitions, and then guess at what earnings will be left in 2013 and beyond. I'll leave that exercise to the analyst community. While I don't personally give much credence to the stated P/E of 6, I do suspect it will continue to attract value buyers to the stock. This should help create some sort of floor for the stock price.
• Support - The recent low was $22.75. The low price during the crisis of 2009 was $25.39. A chartist will see those as support levels.
• Resistance - Prior to this news, the stock had traded around the $35 level for a long time. It then fell toward $30 before gapping down to the low. A chartist might believe the stock will try to fill the gap and trade toward $30. Also a 50% Fibonacci retracement between about $35 and $23 gets to a level around $29. The common sense view of those numbers is that there are a lot of investors out there with underwater positions who will be glad to bail on the stock once they get most of their money back.
• Noise - During the coming months there are likely to be potential rumors around the implementation of HPQ's strategy (i.e. reports on what is the value of the PC business, who might buy what pieces of HPQ, management changes, etc.). This type of uncertainty could serve to both keep some ceiling on the stock price and drive short-term volatility.

From that info, my conclusion is the stock could trade in the range of $25 to $29 for some time and be somewhat volatile. Hence, my plan is to trade options around the established stock position with the intent of generating some profits to offset the big loss in the position.

Trade Execution

As HPQ traded above $26 this week, my initial trade was to establish a $26- $28 1x2 call spread in October. That means one lot of $26 calls was bought and two lots of $28 calls were sold. This trade was established for just $25 total out of pocket costs, so almost no additional capital is at risk if the stock falls. If the stock rises to $28 or higher by the October expiration, one lot of the established position will be called away at $28 and the option spread will be worth $2. That would be similar to selling one lot of shares for $30 which is about the best case scenario based on the above thesis. More likely, if the stock remains volatile, this ratio spread may start trading in the money, and offer a chance to take some profits before October expiration.

Another possible trade, especially on a pull back closer to $25, would be to sell some puts at $22 or lower. This could generate a few percent of income to offset some of the loss in the stock, but would require risking some more capital.

A major drop in a stock position is one of the most challenging situations an investor will face. The extreme strategies of panic selling or waiting to get back to even are not traditionally the best approaches for the situation. Using options to try to capitalize on the consolidation of the stock price might be the best alternative available.

Disclosure: I am long HPQ.

Additional disclosure: This posting is for informational, educational and entertainment purposes only and should not be considered investment advice.