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Meta Platforms (META) stock seems stuck in a trading range - despite the recent market rally. This is good for short sellers of near-term out-of-the-money (OTM) put options as an income play for existing shareholders of META stock.
I discussed this situation in my recent Nov. 27 Barchart article, “Meta Stock Could Be 30% Undervalued - Shorting OTM Puts Is a Good Income Strategy.” At the time META stock was at $339.54 and I recommended selling short the $325 strike price put option expiring Dec. 22.
Today META stock is at $336.00, so it has stayed essentially flat in the last 2 weeks despite the market rally. Nevertheless, my analysis shows that META stock could be worth over 30% more.
Why META Could Be Worth More
The reason is my analysis shows that META stock could be worth $1.136 trillion using a 5% free cash flow (FCF) yield on next year's estimates of FCF. Using a 40% FCF margin I estimated that Meta could produce $56.8 billion in FCF.
So, dividing $56.8b by 5% results in a $1,136 billion market cap estimate. Comparing that with its present market valuation of $867.4 billion, we see that META stock could rise by 30.8%.
In other words, META stock could be worth $439.50 in the coming year (i.e., 1.308 x $336.00).
One way to play this while waiting for META stock to rise is to sell short out-of-the-money (OTM) put options. This allows existing shareholders to get paid while they wait. Note that Meta Platforms still does not pay a dividend even though it generates huge amounts of free cash flow.
Shorting OTM Puts in Near-Term Expiration Periods
For example, in my last article, as mentioned above, the $325 strike price put short sale resulted in an income of $3.55 per contract. That worked out to an immediate yield of 1.09% (i.e., $3.55/$325.00).
Today, those puts are trading for $1.30 at the midprice. In other words, short sellers of these puts have already made $2.25 (i.e., $3.55 received - $1.30 price today if closed out).
There is only one more week to go and so it makes sense to simply wait for that short play to close out unexercised.
However, some investors might want to secure another short play. Look at the expiration period ending Jan. 5, 2024, expiration period. It shows that the same $325 strike price puts are trading for $3.70 per put on the bid side.
That means that the short seller of these puts makes 1.138% immediately by shorting them (i.e., $3.70/$325.00). The strike price is 3.39% below the spot price, i.e., out-of-the-money (OTM).
More conservative investors might want to sell short the $320 strike price which is almost 5% below today's price. However, the yield is lower at 0.80% (i.e., $2.56/$320). Nevertheless, this still provides a good annualized expected return (ER) assuming the trade is repeated every 3 weeks (i.e., 17 times a year). The ER here is 13.60% (i.e., 17x 0.80%).
Comparing that ER with the $325 strike price ER of 19.35% shows that the investor is giving up about 42% of potential annualized income (i.e., 19.35%/13.60% -1 = 42.25%). However, keep in mind there is a good deal more risk at the $325 strike price.
The downside is that META stock does not rise and falls to $325.00 in the next 3 weeks. That means that the investor would have to buy more META stock at the $325 price. That could result in an unrealized capital loss.
However, the investor could always just wait for META stock to rise to its target price. Or they could short OTM call options to gain extra income. Either way, as long as META stock stays in a trading range it makes sense for existing shareholders to short OTM puts for extra income.
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.
