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Apple (AAPL) stock has been on a tear, up 17%+ since the end of last quarter and +48.5% YTD. For example, in early trading on July 17 AAPL is at $192.84, up 17% from $164.90, where it closed on March 31.
But if Apple's upcoming quarterly free cash flow (FCF) comes in strong as expected, AAPL stock rise even further. In fact, based on our analysis, AAPL stock could cross over $200 per share using a reasonable multiple of FCF.
Free Cash Flow Upside
We discussed this situation in our last article on June 21 in Barchart: “Has Apple Stock Peaked? - Unusual Activity In AAPL Puts Shows One Trader Is Bearish.” In that piece we suggested that the company might be able to come in with FCF that tops its prior year's $20 billion in FCF generation.
For example, if AAPL produces results that show $25 billion in FCF, the market might be willing to give it a greater than 30x FCF multiple. That would raise its market cap to over $3,000 billion (i.e., $3 trillion).
Here is how that would work out. Last quarter ending March 31, Apple made $25.6 billion in free cash flow. This was the result of $28.64 billion in operating cash flow less $2.92 billion in capex spending. Moreover, that quarterly result was comparable to the $25.65 billion in FCF it made a year earlier in the quarter ending March 31, 2022.
Last June Apple generated just $20.378 billion in FCF, based on figures from Seeking Alpha. So, if Apple is able to beat this as well as keep up with the March quarter results, it may produce $25+ billion in FCF.
Assuming the market gives the stock a 3.0% FCF yield, which is equivalent to a 33.3x FCF multiple (i.e.,1/3.0% = 33.3x), the market cap will reach $3.33 trillion. This is seen by multiplying $25 x 4, or $100 billion annually in FCF, and then multiplying that by 33.3x.
That means that Apple stock could rise another 9.9% from its present market cap of $3.03 trillion. In other words, AAPL could trade as high as $211.91 (i.e., $192.84 x 1.099x).
Traders Can Take Advantage of This by Shorting OTM Puts
Whether AAPL stock climbs over $200 or not, traders can take advantage of this situation by shorting out-of-the-money (OTM) put options. Apple will release its results for its fiscal Q3 on Aug. 3. So picking an expiration date after that allows us to capture much of the hype that is in options premiums.
For example, look at the option expiration period ending Aug. 4, 18 days from today. The put options with a strike price of $185.00, which is 4%+ below today's price, offer a premium of $1.48 per put contract.
That means that the trader who shorts these puts can immediately make a yield of 0.80%. That doesn't sound like much, but if the options expire worthless, and the trader can repeat this trade every 3 weeks for a year, the return is 13.6%, since there are over 17 periods of 3 weeks in a year.
For example, if the trader secures $18,500 in cash and/or margin with their brokerage firm (in order to buy 100 shares at $185.00 in case the option is exercised), they can enter an order to “Sell to Open” 1 put contract at $185.00.
The account will then immediately receive $148.00. So if the trader repeats this trade 17 times a year, they will collect $2,516.00 in short-put income. That works out to 13.6% of the $18,500 put at risk in this trade.
Moreover, if the stock does fall to this level or lower they get to own 100 shares at a cost of $185.00. The trader can then turn around and short out-of-the-money (OTM) calls in a covered call trade. This is known as the “wheel” strategy. It allows the investor to make up for any unrealized capital loss they may incur.
Nevertheless, it seems to be a relatively safe way to generate extra income on AAPL stock, especially if it is near a peak now or even if it falls a bit from its present 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.
