/Netflix%20open%20on%20Tablet.jpg)
Netflix (NFLX) stock has been holding up well since releasing its stellar Q3 earnings on Oct. 18. This is ideal for investors following income plays like selling short out-of-the-money put options.
NFLX closed at $459.89 on Monday, Dec. 11, which is off its highs of $479.00 on Nov. 28, but up from lows of $346.19 on Oct. 18. NFLX stock seems to be in a trading range since its earnings release.
I discussed this in our last Barchart article on Nov. 20, “Netflix Stock Could Be Worth 33% More Based on Its Powerful Free Cash Flow.” I argued that NFLX stock was still greatly undervalued based on its powerful free cash flow (FCF).
Netflix's FCF Could Lead to a Higher NFLX Price
For example, I pointed out that Netflix made a 22.1% FCF margin last quarter - i.e., $1.9 billion in FCF divided by its Q3 sales of $8.54 billion. This is likely to rise to 24% or so by the end of next year.
So, if we apply that 24% margin to estimates of $38.2 billion in sales by 2024 year-end, we get an FCF estimate of $9.168 billion. If we assume for valuation purposes that Netflix pays out 100% of that FCF in dividends, NFLX stock would likely end up with at least a 3.33% dividend yield. It could even rise to a 3.0% dividend yield.
That implies that Netflix would have a market cap of $275 billion (i.e., $9.168b/0.0333). And using a 3.0% FCF yield metric Netflix's market value would rise to $305.6 billion. that means that its average market cap estimate is $290 billion.
This is $89.3 billion higher than today's market cap of $201 billion. That is 44.4% higher than today's value. In other words, NFLX stock could be worth 44% more than today's price of $459.89, or $662 per share.
Keep in mind this could take up to a year to occur as the market realizes how much free cash flow the company is going to generate in 2024. Until then, existing shareholders might want to find a way to get paid to wait for this to occur, as Netflix still does not pay a dividend.
One way to do this is to sell short out-of-the-money (OTM) put options in near-term expiration periods.
Selling OTM Puts for Income
I discussed this strategy in my last article discussing selling the $450 strike price puts for expiration on Dec. 15. At the time (Nov. 20), the puts were 3.93% out-of-the-money (OTM) and the premium received was $4.35 per put contract. That works out to an immediate yield of 0.97%, or almost 1.0%.
Today those puts at the $450 strike price have fallen to $1.89 per put in the midprice, a decline of $2.46 or down 56.55%. That means that the short seller of those puts on Nov. 20 has made a 57% gain on their investment.
However, these puts are now only 2.15% below today's stock price. It might make sense to roll this play over to the Dec. 29 expiration period which is about 3 weeks away.
For example, the $440.00 strike price puts have a premium of $2.47 on the bid side. That strike price is 4.26% below today's price and provides more downside protection. Moreover, this still represents a yield of 0.56% (i.e., $2.47/$440.00) to the short seller.
That works out to an annualized expected return (ER) of 9.52% (i.e., 0.56% x 17) as there are 17 periods of 3 weeks in a year. That is a very good return. It also is a higher yield than the remaining period on the prior expiration period.
The bottom line is that NFLX stock has a huge upside and existing investors can make good income by shorting OTM puts in near-term expiration periods.
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.
