Shopify Inc (SHOP) stock has been rising as analysts and investors realize its free cash margins are improving. As a result, it continues to make sense, especially for existing investors, to sell short out-of-the-money put options.
SHOP stock is at $66.62 in midday trading on Friday, June 28. This is up over $10 or +18% from its recent low on May 24 of $56.97.
Moreover, the stock still looks cheap to analysts. I discussed this in my recent June 10 Barchart article, “Shopify Stock Is Still Off Its Highs and Looks Cheap - Selling Short OTM Puts Works.”
Moreover, I recommended shorting the $60 put option expiring on July 5 and that has worked out well. The short play provided a 1.5% yield (i.e., 90 cents income/$60.00 put strike). Today, those puts are trading for just 3 cents.
This play can be rolled over again. More on that later.
SHOP Stock Still Looks Cheap
Analysts still have higher price targets for the stock. Yahoo! Finance says 40 analysts have an average price target of $75.51. Barchart's survey says the average analyst target is $75.99. AnaChart, a new sell-side analyst tracking service shows 36 analysts have an average $74.80 price target.
One way to value the stock is to apply its recent free cash flow (FCF) margins against analyst revenue estimates. Then that FCF estimate can be valued using a FCF yield metric.
For example, as I pointed out in a recent GuruFocus article, Shopify has made positive free cash flow in the past 6 quarters. Recently it made a 12.5% FCF margin on revenue, up from 5.7% a year earlier.
Therefore, assuming revenue averages at least $9.4 billion over the next 12 months (NTM), FCF could hit $1.175 billion (i.e., 12.5% x $9.4 billion).
Using a 1.25% FCF yield metric results in a market cap forecast of $94 billion. Using a 1% FCF yield suggests a $117.5 billion market cap. So, on average it could result in a NTM market cap estimate of over $100 billion (i.e., $105.75 billion). That is 23.5% over its present market cap of $85.6 billion.
In other words, SHOP stock could be worth $82.28 per share over the next year (i.e., 1.235 x $66.62 today).
One way to play this is to sell short out-of-the-money (OTM) puts, especially for existing investors.
Shorting OTM Puts
For example, look at the July 19 expiration period, 3 weeks from now. It shows that the $63 strike price, which is over 5.3% out-of-the-money (i.e., below today's price), trades for 76 cents on the bid side.
That provides an immediate yield of 1.20% to the short seller (i.e., $0.76/$63.00).
Here is what that means. An investor first secures $6,300 in cash and/or margin with their brokerage firm. Then they can enter an order to “Sell to Open” 1 put contract (since each contract represents 100 shares). The expiration date is July 19 and the investor specifies a $63.00 strike price.
The account will then immediately receive $76.00. Therefore the investment yield is 1.20% (i.e., $76/$6300).
Downside Risk and Breakeven
As long as SHOP stays over $63.00 on or before July 19, the account will not be debited $6,300 from the cash secured to buy 100 shares at $63.00. But in any case the investor keeps the $76.00.
Therefore, the actual breakeven price is $63.00-$0.76, or $62.24. That is 6.0% below today's price. This shows that this is a good way to buy into SHOP stock.
Moreover, for existing investors, it provides a way to make additional income. In fact, if you followed my previous article, this would be an additional income play. For example, last article, the investor would have made 90 cents. Even after closing that out at 3 cents today, the return is now 87 cents plus 76 cents today, or $1.63. That represents a total yield of 2.59% on the $6,300 invested over the two periods.
Moreover, existing investors who do this keep all the upside in the stock from their long holdings. In addition, even if the stock falls the investor can later sell OTM calls against their shares.
The bottom line is that SHOP stock still looks cheap. One way to play this is to short out-of-the-money (OTM) puts.
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.