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Meta Platform (META) reported excellent Q2 results on July 26, including a 147% YoY gain in free cash flow (FCF). Moreover, based on its 34% FCF margin, Meta stock could keep rising from its present price of $314.45 in early trading on Aug. 7, giving traders good stock options plays.
For example, FCF reached almost $11 billion during the quarter, which represented 34.375% of its $32 billion quarterly GAAP revenue. This massive FCF was 147% higher than last year's Q2 $4.45 billion in FCF.
Moreover, it was also 59% higher than even last quarter's $6.91 billion in FCF. The Q1 FCF margin was lower at 24.1%, compared to the 34.4% Q2 FCF margin.
As a result, analysts are now very positive on Meta stock and they can forecast a significantly higher stock price based on its FCF margin. This provides a target price that options traders can use in various strategies.
Using FCF For a Target Price for Meta Stock
For example, Seeking Alpha says reports that analysts project $132.5 billion in revenue for 2023 and $148 billion for 2024. The average of these two is $140 billion in revenue for the next 12 months.
Therefore, if we apply its latest 34.4% FCF margin to this $140 billion sales forecast, Meta could generate $48 billion in FCF over the next 12 months. We ca use that to set a price target for Meta stock.
For example, using a 5.0% FCF yield, Meta's market capitalization should eventually hit $960 billion, almost $1 trillion. That can be seen by dividing $48 billion by 5.0%, or, using its inverse, multiplying $48 billion by 20x (i.e., 1/0.05=20x).
As a result, since Meta's present market cap is about $808 billion today, that means META stock could rise by 18.8% (i.e., $960 b/$808 b). This gives us a price target of about $373 per share ($314.45 today x 1.188x).
Let's see how that helps traders with various options plays.
Buying Long Calls and Shorting Near-Term OTM Puts
For example, traders can buy the call options at the $340 strike price, 8% over today's price, for the period ending Oct. 20 for a premium of just over $10 ($10.38). That represents a breakeven price of $350.38, or about 11.4% over today's price, with 74 days until expiration.
This has a good chance of working, since, as pointed out above, we have set a price target of $373 per share for META stock. As it gets close to the end of the year, and assuming its FCF margins stay high, Meta stock could rise to this level.
Moreover, the trader would not necessarily have to wait until the end of the options expiration. That is because, due to extrinsic value left in the call price, as Meta stock rises the call price could move significantly higher as well.
However, to help lower the risk, traders could also sell short near-term out-of-the-money (OTM) put options. We discussed this kind of trade in Meta stock in our recent article on July 23, “Meta's Upcoming Q2 Results Could Be A Boon For Options Traders.”
In that article, we suggested that shorting the $310 strike price puts expiring Aug. 4, which was 5% below the spot price, would be profitable. As it turns out, Meta stock closed higher than that strike price so the option trade was successful as they expired worthless.
Similarly, today, the Aug 25 expiration period shows that the $300 strike price put options, which is 4.4% below today's price, have a premium of $4.03 per put option. This provides an immediate 1.34% yield (i.e., $4.03/$300.00) for a trade that expires in just under 3 weeks.
That means it could easily be repeated up to 4 times (i.e., 74/18) before the related call option trade expires. Being conservative, using a 3x repeat trade, it means that a trader could potentially collect $12.00+ (i.e., $4.03 x 3), which more than covers the $10.38 cost of the call option play.
In effect, then if Meta stock starts to rise toward our $373 price target, we have a relatively riskless way to play the upside in the stock.
This shows that there are good ways to play the potential upside in Meta, based on its massive free cash flow.
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.
