Data-mining-software group Palantir Technologies (NYSE:PLTR) announced Q4 and FY20 financial results on Feb. 16. Following the release, its shares have been volatile and come under pressure.
We recently discussed in detail how investors might consider writing covered calls. Readers who are new to options might want to revisit that article before reading this post.
Today, we'll look into using an options strategy with Palantir stock. This piece should help increase reader understanding of options. For more experienced investors, it is likely to offer ideas for future trades.
Palantir Technologies
- Current Price: $29.49
- 52-Week Range: $8.90 - $45.00
- Year-to-date (YTD) Price Change: Up about 22%
Denver-based Palantir Technologies was founded in 2003 by internet entrepreneur Peter Thiel and colleagues. Many might remember him as one of the founders of Confinity, which merged with X.com, an outfit set up by Elon Musk, the current CEO of Tesla (NASDAQ:TSLA). The post-merger company became PayPal (NASDAQ:PYPL) and had its initial public offering (IPO) in February 2002.
Thiel was also one of the early backers of Facebook (NASDAQ:FB).
Since its inception, there has been significant interest in Palantir Technologies. For instance, its collaboration with various government agencies, like the US's Central Intelligence Agency (CIA), has been regarded as secretive and even controversial.
PLTR stock began trading on the Big Board on Sept. 30, 2020. Instead of an IPO, the company had a direct listing (DPO). This means, as opposed to offering new shares of PLTR stock, existing shareholders sold some of their shares to new investors.
Since its market debut, at an opening price of $10, PLTR shares have had a significant run-up. In late January, the stock hit a record high of $45.
So, the proverbial $1,000 invested in PLTR shares at the time of its public debut would now be worth about $2,900.
Its forward P/E and P/S ratios stand at 263.16 and 55.10, respectively, pointing to a frothy valuation level even for a growth stock like Palantir.
As a momentum stock, PLTR shares are likely to be volatile in the short run. Selling pressure around the date of an earnings report is also common in growth companies. Therefore, a covered call might be an appropriate strategy for some investors.
Covered Calls On PLTR Stock
For every 100 shares held, the strategy requires the trader to sell one call option with an expiration date at some time in the future.
As we write, Palantir stock is trading at $29.49. A stock option contract on PLTR (or any other stock) is the option to buy (or sell) 100 shares.
Investors who believe there could be further short-term profit-taking soon might use a slightly in-the-money (ITM) covered call. A call option is ITM if the market price (here, $29.49) is above the strike price.
So the investor would buy (or already own) 100 shares of Palantir stock at $29.49 and, at the same time, sell a PLTR Mar. 19, 2021, 28-strike call option. This option is currently offered at a price (or premium) of $4.72.
An option buyer would have to pay $4.72 X 100 (or $472) in premium to the option seller. This call option will stop trading on Friday, Mar. 19, 2021.
The 28-strike offers more downside protection than an at-the-money (ATM) or out-of-the-money (OTM) call.
Assuming a trader would enter this covered call trade at $29.49, at expiry, the maximum return would be $323, i.e., ($4.72-($29.49-$28)) X 100, excluding trading commissions and costs.
Risk/Reward Profile For Unmonitored Covered Call
An ITM covered call's maximum profit is equal to the extrinsic value of the short call option.
The intrinsic value would be the tangible value of the option if it were exercised now.
Thus, our PLTR call option's intrinsic value is ($29.49-$28) X 100, or $149.
The extrinsic value is the difference between the market price of an option (or the premium) and its intrinsic price. In this case, the extrinsic value would be $323, i.e., ($472-$149). Extrinsic value is also known as time value.
The trader realizes this gain of $323 as long as the price of PLTR stock at expiry remains above the strike price of the call option (i.e., $28).
At expiration, this trade would break even at a Palantir stock price of $24.77 (i.e., $28-$3.23), excluding trading commissions and costs.
Another way to think of this break-even price is to subtract the call option premium ($4.72) from the underlying PLTR stock price when we initiated the covered call (i.e., $29.49).
On Mar. 19, if PLTR stock closes below $24.77, the trade would start losing money within this covered call set-up. Therefore, by selling this covered call, the investor has some protection against a potential loss in the case of a decline in the underlying shares. In theory, a stock's price could drop to $0.
What If Palantir Stock Reaches A New All-Time High?
As we have noted in earlier articles, such a covered call would limit the upside profit potential. The risk of not participating in PLTR stock's potential appreciation fully would not appeal to everyone. However, within their risk/return profile, others might find that acceptable in exchange for the premium received.
For example, if Palantir stock were to reach a new record high and close at $46 on Mar. 19, the trader's maximum return would still be $323. In such a case, the option would be deep ITM and would likely be exercised. There might also be brokerage fees if the stock is called away.
Bottom Line
In the long-run, we are bullish on Palantir Technologies. However, as a tech company that has recently started trading, its shares are likely to be choppy.
The exact market-timing of when PLTR shares might take a breather is difficult to determine, even for professional traders. But options strategies provide tools that might prepare for sideways moves or even falls in price in stocks.
There are many angles involved in using various options for hedging or speculative purposes. Interested readers might consider putting in the time and effort to educate themselves further.
Meanwhile, from readers' comments posted in the past two weeks, we appreciate that there is interest in understanding the details of covered calls as well as other types of options.
In the future, we hope to expand the range of options that might pique more readers' interest.