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PayPal Holdings (PYPL) LEAPs (long-dated call options) look attractive here to value investors. This is based on the significant upside still in PYPL stock. PayPal's strong free cash flow and FCF margins imply a 21% upside at $105 per share.
PYPL closed at $86.86 on Friday, Dec. 28, off of its peak of $91.30 on Dec. 16. However, this is up significantly from its recent trough of $77.25 on Nov. 1, just after its Q3 earnings release on Oct. 29.
This article will show why PYPL could be worth 22% more or $106 per share based on its strong FCF margins and how to play them with in-the-money (ITM) LEAPs.
PayPal's Strong FCF
I discussed PayPal's valuation and using LEAPs (long-term anticipation securities) in a Nov. 20 GuruFocus article: “PayPal LEAPs Could Be a Winning Play.” LEAPs are long-dated call options, generally trading with an expiration date over 1 year away. They provide a leveraged way to buy PYPL.
In the article, I show that PayPal has generated over $5.4 billion in adjusted free cash flow (i.e., operating cash flow minus capex spending) over the last 4 quarters:
That worked out to 17.3% of its $31.5 billion in revenue over the past year - i.e., a 17.3% FCF margin:
We can use this to estimate forward FCF. For example, management indicated in its earnings slide deck (page 11) that it expects to make $6 billion in adj. FCF during 2024.
Analysts now project that revenue for 2024 will be $31.71 billion, according to Seeking Alpha's survey of analysts. Therefore:
$6b FCF /$31.73 billion revenue = 0.1892, or an 18.9% FCF margin
Since 2025 revenue estimates are now $33.51 billion, we can forecast at least $6.33 billion in FCF next year:
$33.51b x 0.189 = $6.33 billion FCF
Valuation
To see how this affects the valuation, let's assume the market will value the company with a 6.0% yield. For example, theoretically assuming the company pays out 100% of its FCF as dividends, the market might give it a 5 or 6% dividend yield.
Therefore, we back out its estimated valuation by dividing the FCF estimate by 6.0%:
$6.33 b / 0.06 = $105.5 billion
Since PayPal presently has an $87.08 billion market capitalization, this implies the stock is undervalued:
$105.5b / $87.08b = 1.2115 -1 = 0.212 = +21.2% upside
Therefore, PYPL is worth $105 per share:
$86.86 price today x 1.21 = $105.10 target price
Analysts Agree PYPL Looks Cheap Here
In my Nov. 20 GuruFocus article on PYPL, I wrote that analysts surveyed by AnaChart.com had an average price target of $102.91. Now those same 37 analysts have raised their average price target to $107.91 per share. (Note this is close to my $105 price target as well.)
In other words, they are getting more bullish on the stock, even though it has risen.
This can be seen in the table below:
It shows that analysts have raised their price targets over the past month. Note also that these analysts have very high "Price Targets Met Ratio" performance. For example, Colin Sebastian of Baird has been right over 93% of the time he set a price target for PYPL stock - and he just raised his price target again to $91.00 per share.
That should give investors a good deal of confidence in investing in PYPL for the long term. One way to do this, on a leveraged basis, is to buy in-the-money (ITM) long-dated calls.
LEAPs as a Cheap But Leveraged Way to Buy PYPL Stock
In my Nov. 20 GuruFocus article, I discussed buying calls expiring on Dec. 19, 2025, at the $70.00 strike price. At the time, PYPL was at $81.31, so these 1-year + calls were already $11.31 in-the-money (ITM) - i.e., $81.31 - $70.00 = $11.31.
Since the price of the calls was $19.95, that means over half of the premium paid (i.e., $11.31/19.95 = 56.7%) has intrinsic value. That makes it a relatively less risky trade than at-the-money calls.
The advantage was that the investor only had to put up $1,995 to buy 100 shares, rather than $8,131 (i.e., $81.31 x 100).
Here's how these LEAPs performed: Today, over 1 month later, PYPL stock is up 6.83% (i.e., $86.86/$81.31-1), but the Dec. 19, 2025 calls at $70 at trading for $24.03. That means the gain is over 20% (i.e., $24.03/$19.95-1 = 0.2045) in the same period.
In other words, the leverage was 300% with LEAPs:
+20.45% LEAPs performance / +6.83% PYPL return = 2.99x
Therefore, let's look at a new tranche to invest in.
Long-Dated Calls in PYPL
For example, look at the Jan. 16, 2026 expiration call options at the $75.00 strike price. This is in-the-money (ITM) by $11.86 (i.e., $86.86-$75.00), so the intrinsic value is almost equal to the $11.31 intrinsic value in the example above for the Dec. 19, 2025 calls.
The premium is $21.78 at the midprice, so the intrinsic value represents over half of the premium (i.e., $11.86/$21.78 = 54.4%). That helps lower the overall risk in this kind of play.
Note that the Delta ratio is 0.753. That means for every $1 rise in the PYPL stock the call option account value will rise by $75.00 (i.e., 0.753 x 100 shares per contract = $75.30). That is why this kind of investment is so powerful with leverage.
Why do these long-dated calls?
- First, this is a leveraged and cheaper way to buy into the stock's potential upside.
- Second, by choosing a date over one year away, the investor could potentially hold these calls over one year and if sold after 365 days plus one day, the investor can be taxed at the lower 20% long-term capital gains rate, rather than a higher less-than one-year rate (i.e., the investor's marginal income rate).
- Third, since call options tend to lose most of their extrinsic value in the last month, this allows the investor to hold the LEAPs for over 1 year and about 1 month before expiration.
The bottom line is that PYPL stock looks undervalued here. One way to play this is to invest in long-dated, in-the-money (ITM) call options with over one year to expiration.
