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Apple (AAPL) stock is moving up off of lows after its fiscal Q3 earnings report released on Aug. 3. Value investors are buying AAPL stock based on its powerful free cash flow. As of Friday, Sept. 1, AAPL closed at $189.46.
Apple's earnings also appeal to traders who sell short out-of-the-money (OTM) put options. This is because they provide a way for investors to make additional income.
Apple stock has a low 0.51% dividend yield. So, shorting OTM puts while also owning shares in AAPL stock increases investors' income while they wait for AAPL stock to rise.
Apple's FCF and Price Targets
I discussed Apple's earnings in our last Barchart article on Aug. 6, “Apple Stock Tumbles After Earnings, But Its Free Cash Flow Growth Makes It a Buy.” I showed that AAPL stock could be worth between $206.19 to $257.88 per share based on its powerful free cash flow (FCF).
This is because by applying a 41% FCF margin to forecasts of$407 billion in sales for the year ending Sept. 2024. This comes from estimates of 68% FCF margins from its services division and 30% FCF margins from products. Since services will be about 30% of sales, the combined margin is 41.4%.
As a result, Apple's FCF could reach $169 billion next year (i.e., 0.414 x $407b). That means at a 5% FCF yield its market cap could rise by 13.9% to $3.37 trillion (i.e., $169b/.05), up from $2.96 trillion today. Moreover, at a 4% yield, its market cap could become $4.225 trillion, or 42.7% higher.
This means AAPL stock has an upside range of between $215.61 to $270.36 per share (i.e., 13.8% to 42.7% higher).
So, on average investors expect an average price target of $243 per share. That implies a potential upside of 28.3% from Friday's price. This makes shorting OTM puts in AAPL stock for near-term expiration very attractive to income investors.
Shorting OTM Puts
For example, the $180 strike price for put options expiring on Sept. 29, which is 27 days from now, trades for 93 cents per contract. That provides an immediate income of 0.517% for traders who sell short these put options.
Moreover, on an annualized basis that works out to 6.20% if the trader can repeat this trade each month for a year.
Here is what that means on a practical level. If an investor invests $18,000 in cash and/or margin with their brokerage firm they can use this strategy. Keep in mind that a portion, up to 50% of any AAPL shares already owned can provide some of the cash/margin required.
Next, the investor can enter an order with the brokerage firm, after receiving approval to sell short OTM puts, to “Sell to Open” 1 put contract at the $180 strike price. This means that the investor hopes that AAPL stock won't fall to $180, or 5% below today's price on or before Sept. 29. But even if it does, the account has the necessary cash/margin to purchase 100 shares at $180 per share.
Lastly, the account will immediately receive $93 in the account. That shows that this investment provides a yield of 0.517% since $93 divided by the $18,000 invested here in this trade works out that yield. If repeated each month the account will receive $1,116, which works out to 6.20% of the $18,000 invested each month.
As a result, investors who own shares in AAPL stock, which is worth 28% more than today's price, can make additional income. Using this strategy allows investors to keep their shares even if the stock falls. The only risk at that point is that they would purchase more shares at a lower price.
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.
