PayPal: Options Strategy To Generate 17.1% Yield With -27.4% Downside Protection

Summary:

• The market did not like PayPal Holdings, Inc.’s Q2 2023 earnings, sinking the stock back close to 52-week lows.
• We present a put spread strategy to generate 17.1% yield with -27.4% downside protection.
• The full premium is earned if PayPal Holdings stock remains above $45 on January 19th, 2024.

PayPal Holdings, Inc. (NASDAQ:PYPL) reported earnings last week, and the market wasn’t happy about the numbers, especially with active users slipping again from the previous quarter. PYPL closed -12.32% lower on results day.

However, PayPal Q2 earnings were actually in line with consensus, and the 2023 EPS guidance was also reiterated at $4.95, corresponding to a 2023 P/E ratio of 13.2 which is fairly low. Moreover, the company continues to return capital to shareholders via buybacks, which are expected to reach a total of ~$5B in 2023 (not insignificant for a company with a market cap of $81B).

The company is still expected to grow both top and bottom line numbers next year. However, the main risk that the market fears is that the declining active user base will pressure future growth and margins.

According to Seeking Alpha author Vladimir Dimitrov (see PayPal: 3 Reasons Why I Am Optimistic After The Quarterly Results), PYPL is undervalued vs. its peers on the basis of revenue growth:

As we see down below, expected revenue growth rate is still a major factor that could explain differences in Price-to-Earnings multiples in the sector. Even a company like Block (SQ), which struggles to achieve operating profitability is rewarded with exceptionally high earnings multiple on a forward basis due to its strong revenue growth.

More importantly, however, PayPal is now priced well-below the implied earnings multiple by its expected revenue growth rate of 8.4%.

PYPL does appear to be undervalued here, and investors who have very high conviction in the company may well wish to simply buy the common stock and participate fully in both the upside (and downside) of the stock from this point out.

We specialize in generating income through selling options or option spreads. This is a great option (no pun intended) for those investors who may wish to participate in limited profit movement in the underlying stock, while protecting their investment with a wide margin of safety.

Although PYPL does not pay a dividend, we can generate “yield” from this stock using options. By selling put options on PYPL, we are taking a bullish stance because we are committing to buying PYPL if it declines below the strike price.

This particular bull put spread idea generates 17.1% annualized yield in PYPL from now until January 19th, 2024, with -27.4% margin of safety.

The trade

(data updated as of August 9, 2023.)

The Trade: PayPal Holdings, Bull Put Spread 45/37.5 expiring January 19th, 2024, stock price at $62.02.

• Sell PYPL $45 Put for $0.96.
• Buy PYPL $37.5 Put for $0.37.

Ticker: PYPL.

Expiration: January 19th, 2024.

Type: Sold Bull Put Spread.

Upper Strike Price: $45.

Price Move Until Upper Strike: -27.4% decrease.

Premium Collected: $0.57 or $57 per contract.

Days To Expiration: 162 days.

Annualized Return: 17.12%.

Breakeven: $44.57 (Max loss $693 per contract achieved if the stock goes below $50).

Option Volume: Good, with a $0.60/$0.57 bid-ask spread at the time of writing.

To protect the position from further downside in PYPL, I’m going with a relatively conservative bull put spread idea with an upper strike price of $45, which is-27.4% below the current stock price and also -23.7% below the 52-week low of $58.95. A price of $45 would bring us back to 2017 prices, when PYPL’s revenue was only a small fraction of what it is today.

The lower strike price is $37.5, giving a maximum loss of $7.5 not counting the premium received.

The put spread expires on January 19th, 2024, and can be sold for $0.57, giving an annualized premium yield of 17.12% (assuming a capital requirement of $7.5, the difference between the two strike prices). Together with an interest rate of 4.83% (Interactive Brokers) on the cash secured by the put spread, this rises to a total annualized yield of 21.95%.

An investor writing this put should be comfortable with any of these three scenarios occurring on the expiry date of January 19th, 2024:

1. PYPL closes above $45: The option will expire worthless, and the investor pockets the $0.43 premium and earns 17.12% annualized yield (21.95% with interest) over the life of the option.
2. PYPL closes between $45 and $37.5: The investor will be forced to take assignment of PYPL shares at $45, while the lower put will expire worthless. (but you still get to keep the $0.57 option premium, effectively reducing your cost basis to $44.43).
3. PYPL closes below $37.5: Both long and short puts will be assigned, and the investor will experience the maximum loss of $6.93.

Remember that each option contract represents 100 shares of the underlying and that anyone trading options should be fully familiar with the risks as set forth here.

---

Analyst’s Disclosure: I/we have a beneficial long position in the shares of PYPL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

---

Interested in more income ideas?

Check out Cash Builder Opportunities where we provide ideas about high-quality and reliable dividend growth ideas. These investments are designed to build growing income for investors. A special focus on investments that are leaders within their industry to provide stability and long-term wealth creation. Along with this, the service provides ideas for writing options to build investor’s income even further.

Join us today to have access to our portfolio, watchlist and live chat. Members get the first look at all publications and even exclusive articles not posted elsewhere.