Charles Schwab Corporation (NYSE: SCHW) shares traded higher on Monday but remain down 10% in the past two weeks after Schwab and most of its discount broker peers completely eliminated trading fees on stock and ETF trades. Sellers are concerned about Schwab’s ability to maintain and grow revenue once it loses most of its trading commissions.
Despite the price weakness, some large options traders are making some big bets on a near-term Schwab rebound.
On Monday morning, Benzinga Pro subscribers received three option alerts related to unusually large trades of Schwab:
- At 11:18 a.m., a trader sold 1,250 Schwab call options with a $38 strike price expiring on March 20, 2020 at the bid price of $3.25. The trade represented an $406,250 bullish bet.
- At 11:50 a.m., a trader bought 1,415 Schwab call options with a $42 strike price expiring on Nov. 22 near the ask price at 25 cents. The trade represented an $35,375 bullish bet.
- At 12:15 a.m., a trader bought another 826 Schwab call options with a $42 strike price expiring on Nov. 22 near the ask price at 25 cents. The trade represented a $20,650 bullish bet.
The last two trades represent a more than $55,000 bullish bet with a break-even price of $42.25, suggesting Schwab shares have at least 12.1% upside in less than six weeks.
Why It's Important
Even traders who stick exclusively to stocks often monitor option market activity closely for unusually large trades. Given the relative complexity of the options market, large options traders are typically considered to be more sophisticated than the average stock trader.
Many of these large options traders are wealthy individuals or institutions who may have unique information or theses related to the underlying stock.
Unfortunately, stock traders often use the options market to hedge against their larger stock positions, and there’s no surefire way to determine if an options trade is a standalone position or a hedge. In this case, given the relatively modest sizes of the three individual Schwab call trades, they were unlikely to be institutional hedges in this instance.
Life Without Trading Fees
The knee-jerk reaction to the trading commission cuts may prove overzealous if Schwab and others find a way to replace that lost trading revenue via other means, such as payment for order flow. Fee revenue accounts for less than 10% of Scwab’s total revenue, according to CFRA, making Schwab potentially less vulnerable to the transition than its peer group.
Regardless, Wells Fargo recently downgraded Schwab following the commission cuts and said slowing organic revenue growth, falling interest rates and disappearing commission revenues will limit upside for discount brokers in the near term.
Monday’s call buyer(s) may be hoping Schwab management will be able to ease concerns over the fee cuts and eliminate uncertainty when the company reports third-quarter earnings on Tuesday morning before the open. The buyer may feel the valuation risk-reward balance for Schwab has shifted to the upside following the recent sell-off in the discount broker group.
Unfortunately no matter how optimistic management is on Tuesday’s earnings call, investors won’t get definitive clarity on just how much of an impact commission-free trading will have on the company’s finances until fourth-quarter earnings in January.
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