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Amazon (AMZN) stock has risen to a peak price of $151.94 at year-end 2023. But AMZN is still worth at least $185 per share based on its powerful free cash flow. Moreover, shareholders can gain extra income while they wait for this target price by selling short out-of-the-money (OTM) put options.
I discussed these points in my Nov. 28 Barchart article, “Amazon Could Be Worth $181 Per Share, 23% on Its Powerful Free Cash Flow.” At the time AMZN was at $147.45 per share and I recommended shorting the $140 strike price put for 85 cents and the $142 strike price put for $1.25 - both for expiration on Dec. 15.
As it turned out, on Dec. 15 AMZN closed at $149.97, and the put trades remained out-of-the-money. That means the short sellers of these puts were not obligated to buy the stock with the cash secured for the trades. They also kept the income generated which worked out to 0.607% and 0.88% respectively.
So we should look at doing these trades again. But first, let's review why AMZN stock could be worth 22% more at $185 per share.
Free Cash Flow Could Push AMZN Stock Higher
Here is why Amazon stock could fly higher. In the last 12 months (LTM) Amazon has generated $21.4 billion in FCF on $554 billion in sales. That represents almost a 4% FCF margin ($21.4b/$554b = 3.8%).
Since 53 analysts surveyed by Seeking Alpha now estimate that 2024 revenue will hit $636.43 billion, that implies FCF could rise to $25.5 billion (i.e., 4% x $636.43b).
The next step in the valuation assumes that, for valuation purposes, Amazon was to pay out all its FCF as a dividend. Our best guess is that the market would give the stock a 1.5% dividend yield. This is typically the yield that high-tech stocks get when they pay out dividends.
So, using a 1.333% FCF yield, implies that the market cap for Amazon would rise $1,913 billion. That is seen by dividing $25.5 billion by 1.333%, which is also the same as multiplying $25.5 billion by 75x (i.e., the inverse of 1.333%).
This market cap is 21.85% higher than its existing market valuation of $1,570 billion. So, if we multiply the present price of $151.94 by 1.2185 we get a target price of $185.14 per share.
Shorting OTM Puts for Income
As shareholders wait for the stock to rise to this target price they can generate extra income by shorting OTM puts, as mentioned above. For example, the Jan. 19, 2024, expiry period, about 3 weeks from today, shows that there are attractive income plays.
One play is to sell short the $146 strike price puts, which are 3.91% below today's spot price, i.e., out-of-the-money. The premium received by the short seller is $1.13 on the bid side.
That works out to a 0.774% yield that is immediately received by the short seller. Moreover, if this trade is repeated every 4 times every quarter the total expected return (ER) is 3.1%.
Here is what that means on a practical basis. The short seller secures $14,600 with their brokerage firm, either using cash or a mixture of cash and/or margin. That allows the account to automatically buy 100 shares should the short put contract get exercised if the stock falls to $146.00 on or before Jan. 19.
Next, the short-seller enters an order to “Sell to Open” 1 put option contract at the $146 strike price for expiration on Jan. 19. That allows the account to immediately receive $113.00 (i.e., $1.13 x 100 share per put contract). So this is why the yield is 0.774% (i.e., $113/$14,600 = 0.0074).
And if this trade can be repeated 4 times every quarter (i.e., 91 days/20 days to expiration = 4.55 times), the expected return is $452 (i.e., $113 x 4). That represents 3.09% of the $14,600 invested in this play.
In other words, there are ways for existing shareholders to make extra income while they wait for the stock to rise to $185.00 per share.
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.
