Palm (PALM) is in trouble. The company’s latest earnings warning fiasco sent the stock reeling, in what was perhaps the prelude to a deathblow to hopeful shareholders who have remained loyalists. Despite the fact that the stock slid from about $9 to $6, it was impossible last week to not notice how many options traders were actually pressing their bets for more Palm downside.
Then came the ultimate slap from Barron’s on Monday: an article that said Palm’s great phones just aren’t being bought by anyone. In the land of smartphones, Joe Public is going for the iPhone from Apple (AAPL), the BlackBerry from Research In Motion (RIMM) or the new Droid variations from Google (GOOG).
Barron’s threw out the notion that Palm could sink back down toward $3 if the company is not acquired.
Palm may die or be devoured by a rough sea of competition, so why not profit from its misery?
Going too far out in the land of options is probably silly because the time value will end up causing you to pay too much premium.
The PALM Aug 5 Puts (UPY 100821P00005000) cost 74 cents, so you’d have to see the stock hit $4.26 before you had a penny of intrinsic value in that trade, which means it has to drop 30% for you to be right.
After crunching the numbers among strike prices and expiration dates, the pick is the PALM May 5 Puts (UPY 100522P00005000) at 40 cents. The stock has to fall to $4.60 for you to have intrinsic value, but the erosion is only about half a penny per day on time value, and it offers the most leverage if the stock gets another wave down.
This is also the least crowded put contract in the open interest of the closest strike prices. All of the strike prices from $6 to $10 have well over 10,000 contracts each in the open interest, while the open interest is only about 3,000 in the $5 strike.
The other difference here is the 75 or so days until expiration, so unless Palm suddenly screams higher, this contract won’t see any significant price drop for at least another month.
If you’re asking why not just short the stock, the answer is simple. Palm is one of those companies that ultimately will be acquired. That does not mean it will be acquired for a profit or that the common stock won’t ever implode. But it is too easy for Dell (DELL), Hewlett-Packard (HPQ) or one of the weaker cell phone makers to pick Palm up. Nokia (NOK) is one name that has been tossed around as a potential buyer. The idea is not to buy Palm for the great sales history, but for its intellectual property or to consolidate yet another competitor.
Furthermore, using the puts limits your downside to the premium paid. Shorting the stock could ultimately leave unlimited downside if one of the many rumored suitors were to decide they should buy the company sooner rather than later.
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