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Broadcom Inc (AVGO) will do a 10-for-1 stock split next Monday (July 15). Based on its strong FCF and price targets, AVGO stock looks cheap. Selling short out-of-the-money put options is a way to play this and gain extra income.
I discussed this in my last Barchart article on June 14, “Broadcom, an AI Chip Stock, Just Split Its Shares Like Nvidia and Looks Cheap.” AVGO stock was at $1,716.77 and I suggested shorting the $1,640 strike price put expiring July 5 would be profitable.
As it turns out, AVGO stock closed at $1,703.31 on July 5, so the put stayed out-of-the-money (OTM) and the short put play worked. The investor who followed this strategy made $41.60 and a 2.49% yield over 3 weeks (i.e., $41.60/$1,670).
Short Put Plays Will Be Easier with the Split
It will be easier to do these kinds of short-put plays after the stock split goes into effect on July 15. The main reason is that the short seller won't have to secure as much money with their brokerage firm.
For example, look at the strike prices for the July 19 expiration period It shows that the $1,670 strike puts have a bid side premium of $38.80. That provides a very nice yield over the next two weeks of 2.32% (i.e., $38.80/$1,670).
The problem for most investors is that just to do one short put contract, which involves securing enough cash to buy 100 shares, requires $167,000 in cash and/or margin. This is because the strike price of $1,670 x 100 shares equals $167,000.
However, after the stock split on July, the strike price for this play will be $167.00, not $1,670. That means that the investor will only have to secure just $16,700 to sell short one put contract (i.e., 100 shares x $167.00).
Good Yields Shorting AVGO Puts
The investor's account will receive $3,880 for 1 put contract shorted this week. That works out to an immediate yield of 2.32% on the $167,000 invested in this short play.
Starting on July 15, the investor who shorts 1 put contract this week will have an adjusted number of contracts for expiration periods that expire after July 15. But new contracts initiated on or after July 15 will have lower capital requirements.
That will make these short put plays easier to do and so investors can take advantage of these high yields by shorting AVGO puts in OTM expiry periods.
AVGO Stock Is Still Cheap
Investors in these short put plays can also use this strategy as a way to potentially buy into the stock at a cheap price. That makes sense given how cheap Broadcom is right now.
In my last two Barchart articles I discussed this, including the May 12 article. I showed that AVGO stock could be worth as much as $1,980 (i.e., $198.00 post stock-split).
This is based on its strong free cash flow and assumes the company will make a 40% FCF margin over the next year. For example, analysts project $60.66 billion in revenue for the year ending Oct. 2025.
As a result, Broadcom could end up generating $24.26 billion in FCF (i.e., 40% x $60.66b) next fiscal year. The market will likely give the stock at least a 2.5% FCF yield valuation. That means it could be valued at $970.4 billion (i.e., $24.26/0.025).
This is 22.39% higher than Broadcom's existing market cap of $792.87 billion. As a result, AVGO stock is worth 22.39% more, or $2,084.68 (i.e., 1.239 x $1,703.31). That is the same as $208.49 after the split.
The bottom line is that investors shorting AVGO puts won't mind even if their short put plays end up in the money (i.e. the investor has to buy shares at $167.00). The potential capital gain is almost 25% (i.e., $208.49/$167.00-1 = 24.8%).
So shorting out-of-the-money (OTM) puts is a good way of both gaining extra income and setting a cheap buy-in target price.
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.
