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CrowdStrike Inc (CRWD) is set to release quarterly earnings next Wednesday, Aug. 28. This could lead to new volatility in CRWD stock, though it's up from recent lows. However, long-term investors see the stock as a contrarian play, given the company's strong free cash flow (FCF).
One way to invest in this situation is to sell short deep out-of-the-money (OTM) put options. This article will describe why trade makes sense.
CRWD stock is trading for $265.43 per share, up from a recent low of $217.89 on Aug. 2. That represents a recent recovery of 21.8%, although it's still off a recent peak of $390.71 on July 8. That means CRWD stock is still over $125 down from its peak, of -32%.
Given the company's strong free cash flow (FCF) and FCF margins, contrarian value investors are attracted to this kind of play, especially as a long-term investment.
CrowdStrike's Ongoing Value
I discussed this situation in a recent Barchart article on July 21, “Should You Buy CrowdStrike Stock? Its Dip Makes CRWD Appealing to Contrarians.” This was just after the company's disastrous software upgrade and client systems crash the week prior.
I suggested that CRWD stock could still be worth $353 per share based on its strong free cash flow and high FCF margins. I may have been a little early pulling the buy trigger here, but it still makes sense.
For example, I pointed out that CrowdStrike generated 35% FCF margins in its prior quarter. Moreover, analysts project sales next year will be just under $5 billion ($4.93 billion), or 24.5% higher than the roughly $4 billion in sales ($3.96 billion) expected for this year ending Jan. 2025. In other words, over the next 12 months (NTM), its average run rate sales will be $4.445 billion.
Therefore, using a lower 30% FCF margin estimate (from higher software capex expenses), CrowdStrike will still generate $1.33 billion in free cash flow. If we assume the market will value this with a 1.5% FCF yield metric, its market cap could rise to $88.9 billion (i.e., $1.33 billion/0.015).
That is 37.5% higher than its existing market cap of $64.64 billion. In other words, CRWD stock could be worth at least 37% more or $363 per share sometime in the next 12 months.
Even using a 1.75% FCF yield metric (which is the same as 57x FCF), the market cap would be $76 billion, or +17.6% higher than today. That puts the minimum target price at $312.15 per share. No wonder contrarians are attracted to this play.One way to conservatively play this is to short out-of-the-money (OTM) put options in nearby expiry periods.
Shorting OTM Puts
For example, look at the Sept 6 expiration period, 18 days from today, and just after the company releases its upcoming earnings. Given how volatile the stock has been, and the fact that short seller may try to push it lower again, it makes sense to look at deep out-of-the-money (OTM) put strike prices.
One example is the $242.50 strike price expiring Sept. 6. That strike price is almost 9% below today's price. However, the premium is still high at $6.25 on the bid side. That means that a short seller of these puts over the next 2 weeks+ can make an immediate yield of 2.58% (i.e., $6.25/$242.50 = 0.02577).
This is very attractive to long holders of CRWD stock. They can make extra income which may help improve their existing unrealized losses in the stock. Moreover, even if the shares fall 10% to this strike price, the breakeven buy-in is lower at $236.25 (i.e., $242.50-6.25, or 11.2% below today's price.
Some less risk-averse investors may want to short the $247.50 strike price. That short-put play yields over 3% (i.e., $7.80/$247.50 = 3.15%). Moreover, the breakeven price is still cheap at just $239.70 (i.e., $247.50-$7.80), or 9.88% below today's price.
That means that CRWD stock would have to drop another 10% in the next 2 weeks for this play to be somewhat unprofitable. Moreover, combining this play with prior short-put plays, even ones that ended up in the money as described in my last article, still helps lower the investor's average buy-in cost.
Given that CRWD stock looks deeply undervalued here, this could be an attractive contrarian play for long-term value investors.
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.
