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Palo Alto Networks (PANW) stock has held up well in the last month, especially compared to other tech stocks. This makes it ideal for short sellers of out-of-the-money put options to gain extra income.
PANW stock is at $236.25 in morning trading on Monday, Oct. 2. That is down from $242.72, where it closed on Sept. 1. So, it is off just 2.5% in the last month.
Moreover, we previewed this in our Sept. 3 Barchart article, “Palo Alto Networks Stock Is a Major Bargain, Especially for Short Sellers of Its Puts.”
FCF Margin-Based Target Price
In that article, we discussed Palo Alto Network's strong adjusted free cash flow (FCF) and why this made PANW inexpensive.
For example, in the last quarter ending July 2023, the company's adj. FCF margins were over 38.7%. In the prior year, its adj. FCF margin on sales was 33%. So, going forward, one might expect to see an average adj. FCF margin of 35.85%.
Using that figure we estimate that the company could make almost $3 billion in adj. FCF for the year ending July 2024. This is because analysts' estimates of $8.17 billion in sales multiplied by 35.85% produce a figure of $2.93 billion in adj. FCF.
Next, using a 3.0% FCF yield metric we can set a price target for PANW stock. For example, if we divide the $2.92 billion in forecast adj. FCF by 3.0% (the same as multiplying it by 33.3x), PANW stock could have a market cap of $97.3 billion.
That is 33% higher than its market cap today of $73 billion. This implies that PANW stock could be worth $314.70 sometime in the next year.
In fact even at 31x adj. FCF, PANW stock would be worth around $300 per share, or 27% over today's price.
This means the stock has a good upside, which makes it ideal for investors who hold the stock.
They can also make extra income, especially since the company does not pay a dividend, by shorting out-of-the-money (OTM) put options in near-term expiration periods.
Shorting OTM Puts in PANW Stock
For example, in my last article, I discussed selling short the $230 strike price put options for the period expiring Sept. 29. At the time, the premium received was $2.30 per put contract. Those puts were OTM by 5.24%.
That trade yielded a 1.0% return for short sellers over the 27 days. Moreover, the stock closed above $230 by the end of Sept. 29, so there was no obligation to purchase the stock at $230 per share.
Today, a similar return can be made by selling short the Oct. 27 puts at the $220 strike price, which is over 7% below today's price. Those puts trade for $2.02, or 0.918% of the $220 strike price.
That means that an investor who secures $22,000 in cash and/or margin with their brokerage firm can enter an order to “Sell to Open” 1 put contract at $2.20 per share for Oct. 27. The account will then immediately receive $202. That is 0.918% of the $22,000 that was invested in this trade.
So, if the investor can repeat this trade over the next 12 months, the total expected return could be $2,424, or 11.0% of the total $22K invested in this strategy.
For those willing to take on more exercise risk, they can sell short the $225 strike price puts. Those trade at $3.04, or 1.35% of the strike price, with an expected annualized return of 16.2%.
Moreover, if the investor holds the stock long-term they can reap all the potential upside as described in our target price discussion above.
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.
