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Domino's Pizza stock (DPZ) has retreated from its recent highs but still looks attractive to value buyers. Shorting out-of-the-money (OTM) put options is one way to set a lower buy-in price and get paid while waiting.
DPZ is at $455.29 in midday trading on Tuesday, Dec. 10, from its peak of $476.19 on Nov. 29. However, this is up significantly from Oct. 10 ($408.75) when it released strong earnings and free cash flow (FCF) for Q3.
Nevertheless, value investors like the stock, as seen by Buffett's recent purchases. I highlighted this in my Nov. 15 Barchart article, “Is Domino's Pizza Stock Worth Buying? Buffett Likes Its Huge Free Cash Flow.”
I argued that DPZ is worth $563 per share, or +23.7%, based on its strong FCF and FCF margins. This was based on analysts' projections of $5.04 billion in sales next year and Domino's 13.5% FCF margin as of Q3.
That results in a projected $680 million in FCF in 2025. Using a 3.50% FCF yield valuation metric, the stock could end up with a $19.43 billion market cap (i.e., $680m/0.035).
That is 23.1% higher than its present $15.787 billion market cap. In other words, DPZ should be worth +23.1% more in the coming year, or $560.46 per share.
Analysts Agree DPZ is Undervalued
Yahoo! Finance surveyed analysts with an average price target of $480.65, and Barchart's survey shows a mean target of $484.73. These surveys show that there is at least 6.0% upside in DPZ stock.
However, AnaChart.com, which surveys analysts who've written recently on a stock, shows that the average of 29 analysts is $512.96, or +12.7% higher.
Moreover, as seen in the table below, many of these analysts have recently raised their price targets.
One of these analysts, Alton Stump, of Loop Capital has recently raised his price target to $559, up from $419. Note that he has a very good track record. His “Price Targets Met Ratio” metric is over 70%. That means that over two-thirds of the time his price targets come to pass. That lends a great deal of credibility to his price target upgrade.
One way to play this, to set a buy-in target price, is to sell short out-of-the-money (OTM) puts. That way the investor can wait for a lower price to buy into the stock and get paid until this happens.
Shorting OTM Puts
I highlighted this play in my last article on Nov. 15. I discussed shorting the $420 strike price put expiring this Friday, Dec. 13. At the time the price was $4.40 per put contract, providing the short seller an immediate 1.04% yield over 28 days (almost one month).
Today those puts are trading for just 5 cents on the bid side and seem likely to expire worthless. So, this has been a successful trade for short sellers of these puts and it makes sense to repeat this trade.
For example, Jan. 10, 2025, DPZ puts, one month out, trade for $5.50 on the bid side for the $440 strike price. That provides an immediate short-put yield of 1.25% (i.e., $5.50/$440.00).
Here is what this means. The investor first secures $44,00 in cash or buying power with their brokerage firm. That acts as collateral in case the stock falls 3.33% to $440.00 per share from today's trading price over the next month and the account is assigned to buy 100 shares at that price.
Next, the investor can enter an order to “Sell to Open” 1 put contract at this price. The account will then immediately receive $550. That works out to an immediate 1.25% yield (i.e., $550/$44,000 invested).
Note that there is only a 28.98% delta ratio, indicating less than a 29% chance that the play will be assigned to buy 100 shares at this price. That seems like a low risk.
This is also why existing investors find shorting OTM puts very attractive. Or the investor can buy long-dated in-the-money (ITM) calls along with shorting OTM puts. That way they can gain some of the upside potential in DPZ stock.
The bottom line is that by shorting OTM put options investors can set a lower buy-in target and get paid while waiting. Given the stock's higher price target, this is one play that makes sense for value investors.
