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Salesforce (CRM) stock has taken a hit along with the market. But the stock still looks cheap according to analysts. One way to take advantage of this is to sell short out-of-the-money put options as an income play.
CRM closed at $243.97 on Friday, down $9.09 or -3.59%. Moreover, CRM stock has dropped over 7.1% from $262.71 last Friday. However, this may be overdone.
As a result, it makes sense here to take advantage of elevated put option premiums by shorting them. This article will describe this play.
Analysts Still See Value in CRM Stock
I described how and why analysts still like CRM stock in my July 14 Barchart article, “Analysts Still See Salesforce Stock As a Buy Here - Shorting OTM Puts Is a Good Play.” I showed why Salesforce stock could be worth as much as $289 per share based on its free cash flow (FCF) and high FCF margins.
This is 18.5% higher than today's price. Moreover, analysts still see CRM stock as cheap here.
For example, Barchart's survey shows that the mean analyst target price is $293.27, or +20% higher. Similarly, Yahoo! Finance's survey shows an average price target of $296.55 from 41 analysts.
In addition, AnaChart, a new site that tracks sell-side stock analysts' recommendations, indicates that 38 analysts who have recently written about Salesforce have an average $286.04 price target. That is over 17% higher than Friday's price of $243.97.
It's not likely that these analysts will downgrade their price targets just because the market took a dip this past week.
As a result of the stock's downturn, put option premiums have risen. That provides a unique opportunity for short sellers of deep out-of-the-money puts, especially for existing shareholders.
Shorting OTM Puts for Income
As mentioned above, I discussed this play in my last article on July 14. I suggested shorting the $245 strike price put option that was to expire on Aug. 2, 20 days from then. At the time, CRM stock was at $253.97, so this strike price was 3.53% below (i.e., out-of-the-money) the stock price. That provided some protection for the short seller.
As it turned out CRM closed below the strike price at $243.97. Anyone who followed this advice had their short puts assigned to them. That means they had to buy 100 shares at $245 using the $24,500 cash initially secured with the brokerage firm.
This implies a small unrealized loss of $103 (i.e., $24,397 for 100 shares less the cost of $24,500). However, the investor had also received $2.25 per put contract (i.e., $225) in income.
So the net result is this: -$103 unrealized loss plus income of $225, per contract shorted, or +$122. That still represents a net gain of 0.50% (i.e., $122/$24,500) on the original investment.
This is only for those who did not close out their short-put trade before the expiration. You should always do this, especially if you already have a profit on the day before options expiry.
Redoing the Trade
Now it makes sense to redo this same play. For example, look at the Aug. 30 expiration period, 27 days from now. (That is also close to the company's expected earnings release date of Sept. 4).
It shows that some deep out-of-the-money (OTM) put strike prices still have high premiums. That makes them worth shorting and still provides extra downside in case the stock falls further.
For example, the $215 strike price puts, over 11% below Friday's price, have a bid side premium of $2.19. That works out to an immediate yield of 1.0% to the short seller (i.e., $2.19/$215.00 = 1.018%.
Moreover, for those less risk-averse, the $220 strike price, which is just under 10% out-of-the-money, trades for $3.25 per put contract. That provides a short-seller an immediate yield of 1.48% (i.e., $3.25/$220.00).
You can see that this works best for existing shareholders. They will get the best of two potential outcomes. For example, if the stock rises, they not only keep the short-put income but also get any unrealized gains from the upside in the stock.
On the other hand, if CRM tanks down to these strike prices, the non-shareholder short-put investor has a way of buying into CRM stock at a very cheap price. That happens if the investor holds the short-put play until expiration and the stock falls to $215 or lower. (But, of course, I don't recommend that.)
The bottom line is that CRM stock looks very cheap here, based on its free cash flow and FCF margins, as well as analysts' price targets. One way to conservatively and profitably play this is to short out-of-the-money put options in nearby expiration periods.
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.
