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Amazon (AMZN) stock is up over 15.5% in the last month, closing at $127.11 on June 15, and over 48% YTD. But it still may be a good time to get in, especially if the company generates positive free cash flow this quarter or next. One way to do this is to short out-of-the-money puts at strike prices below today's price.
We discussed this strategy in our last article on Amazon stock on May 21, “Amazon Stock Continues To Slowly Move Higher, Reflecting Faith In Its Free Cash Flow.” Amazon could potentially produce positive free cash flow (FCF) this quarter ending June 30, or next quarter.
Market Expectations
The market seems to be anticipating this. That is why AMZN stock has been rising. Last quarter its FCF was still negative or an outflow. But given positive earnings growth this quarter, analysts seem to be projecting positive FCF very soon. That is unless the US and the global economy slow down and are headed for a recession. So far, that does not seem likely.
For one, Amazon's advertising revenue is on a roll. In addition, Amazon's AWS is a powerful cash generator for the company. As artificial intelligence (AI) takes root across America, corporate needs for cloud data warehousing and systems will keep growing.
Moreover, analysts are also projecting significantly higher earnings per share for next year. For example, Seeking Alpha reports that the average of 42 analysts' forecasts for 2024 is $2.59 per share. That is 66% higher than the average $1.56 earnings per share (EPS) forecast for 2023.
As a result, AMZN stock is still reasonably cheap at today's price of $127.11 (June 15 close). That puts AMZN stock on a forward multiple of 81.5x for 2023 and 49x for 2024. These metrics are well below the stock's 5-year average forward P/E of 190.78x, according to Seeking Alpha.
This means that it still might be a good time to buy AMZN stock. One way to do this cheaply over time is to short out-of-the-money (OTM) puts.
Playing AMZN Stock With OTM Puts
For example, last month we wrote that the $107 and $110 strike price put options for the expiration period ending June 23 looked attractive. They were trading for $1.14 and $1.75 respectively. We wrote that by shorting those puts, which at the time were only 8% and 5.38% out-of-the-money, an investor could both make good income. At these strike prices and premiums, the immediate yields were just over 1% (i.e., $1.14/$107=1.065%, and $1.75/$110.00=1.59%).
Moreover, the investor could potentially buy in at a lower price if AMZN stock fell to these strike prices.
As it turns out, AMZN stock rose from $116.25 to $127.11 today. As a result, these strike price puts are now worth only 2 to 4 cents. That is exactly what the investor wants and it means that the investor has reaped all the income benefits and might as well close out the trade and short another put in a further expiration period.
For example, for the expiration period ending July 7, which is 20 days from today, the $121 strike price puts trade for $1.20 per put contract, and the $122 strike price premiums are at $1.44. This provides potential income of 1.0% and 1.18% respectively for strike prices that are 4.81% and 4.02% below today's price of $127.11.
That means that an investor who secures $12,100 (i.e., $121 x 100 shares) in cash and/or margin with a brokerage firm can then enter an order to “Sell to Open” 1 put contract at $121.00. The account will immediately receive $120. Similarly, by securing $12,200 with the brokerage firm, and entering an order to “Sell to Open” one put contract at $122, the account will receive $144.00.
In both cases, the investor has no obligation to buy AMZN stock unless it falls to the strike price on or before July 7. But at least the investor receives income in return for this obligation to buy the stock in case it falls.
That is one way to average into the stock, assuming it falls to these strike prices. It is also a good way to make extra income while holding AMZN stock for the long term.
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.
