Airbnb (ABNB) stock is very popular these days, especially with value buyers. ANB stock is up over 47% YTD at $125.10 as of June 29, including over 16% in the last month. Investors want to know if this will continue.
One reason it could keep rising is that Airbnb is generating large amounts of free cash flow (FCF). This also makes going long calls and shorting OTM calls popular.
We discussed this situation in a recent Barchart article on June 7, “Unusual Call Options Activity In Airbnb Stock Indicates A Large Bullish Investor.” At the time, ABNB stock was at $116.35 in mid-day trading on June 7.
We reported that a large institutional investor bought over 900 calls at the $117.00 strike price, paying $5.35 for the calls expiring June 30. That made the breakeven price $122.35.
As the price on June 29 was $125.10, these ABNB calls expiring June 30 have been profitable and are now in the money. In fact, as of June 29, the price of the calls was $8.25 at the midpoint. That means the large institutional trader has made 54% (i.e., $8.25/5.35-1=54.2%).
As it stands now it makes sense for investors to roll this trade over and buy long calls for July 21 and/or short out-of-the-money (OTM) calls, as will be seen below.
Why ABNB Stock Looks Worth Buying
As we discussed in our last article, Airbnb is now generating large amounts of free cash flow (FCF) as travel remains popular.
In fact, there is now a term called “revenge travel” where post-Covid vacation and travel surges. This is due to people who are tired of staying stuck in their homes and now want to make up for their lack of travel and vacation during Covid.
One CEO, Ed Bastian of Delta Airlines, said he was shocked at how much this phenomenon is taking over the travel industry. That can only mean good news for Airbnb.
In fact, management said in its Q1 2023 shareholder letter that Airbnb generated $1.6 billion in FCF during the quarter and $3.8 billion over the trailing 12 months (TTM). That represented a 43.6% FCF margin on its LTM revenue.
I wrote that based on this we can expect Airbnb could generate $4.4 billion in FCF on an average of $10 billion in revenue over the next 12 months. So, using a 23x FCF metric, we can estimate Airbnb's market capitalization could reach $101 billion (i.e., 23x $4.4b).
This means that ABNB stock could rise 26.3% over today's market cap of $80 billion. That gives ABNB stock a target price of $157.94 over the next year (i.e., 1.2625x $125.10 price today). We can use this with call buying and covered call shorting option strategies going forward.
Buying ABNB Calls and Shorting OTM Covered Calls
For example, the July 28 expiration calls show that the at-the-money (ATM) strike price of $126 calls trade for $5.00. That makes the breakeven price just $131, or just 4.7166% above the June 29 price of $125.10. Given our price target, it might now be unreasonable for the stock to rise well over $131, or for the call premium to appreciate significantly from here.
For one, Airbnb's earnings will likely come out in the first 10 days of August, so ABNB stock could rise in anticipation of that event. That is possible if investors expect to see large growth in FCF, as happened last quarter.
Another play an investor could make is to short near-term expiration OTM-covered calls or near-term OTM puts. In fact, this could help pay for the $5.00 premium for the long calls expiring July 28.
Here is an example. The July 14 calls at the $131.00 strike price trade for $1.54 per call. That provides a 1.23% covered call yield.
This means that the investor who owns 100 shares (which would cost $12,510, or 100x $125.10 at today's price), can enter an order to “Sell to Open” 1 call at the $131 strike price. The account will immediately receive $154.00 (i.e., $1.54 x 100). That is why the yield is 1.23% since $154/$12,510 is 1.23%).
Unless ABNB stock rises by almost 5% (i.e., 4.72% over today's price of $125.10) to $131 or more by July 14, the investor will not have to sell their underlying shares. They could also sell the call option if that happens as well.
Another potential play is to short OTM puts. For example, the July 14 expiration puts at the $120 strike price trade for $1.60. This strike price is 4.0% below today's price.
So shorting these puts could provide $160 to an investor who secures $12,000 in cash and/or margin with their brokerage firm. That works out to an immediate yield of 1.33%. This is slightly better than the 1.23% covered call yield for a similar width away from the spot price.
Moreover, investors could use this short OTM put trade to help pay for a long call buy, as mentioned above. In fact, if the investor has plenty of cash and/or margin, they could both short the July 14 expiration $131 strike price covered call as well the July 14 $120 short put, collecting $3.14. That would go a long way to paying the $5.00 premium for the $126 calls that expire on July 28.
In other words, there are several strategies that investors can use here to play the potential upside in ABNB stock. That is based on our estimate that it is worth $157.94 as a target price over the next year.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
