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Shorting out-of-the-money (OTM) Amazon.com Inc (AMZN) put options makes sense here as an income play in near-term expiry periods. That especially benefits AMZN stock shareholders as there is no dividend.
AMZN closed at $149.97 on Friday, Dec. 15, 2023, and is at a near-term peak. Moreover, I argued in my last Barchart article that the stock is worth considerably more. I argue it's worth at least $181 per share.
AMZN Stock Upside
This article, “Amazon Could Be Worth $181 Per Share, 23% on Its Powerful Free Cash Flow” bases its argument on Amazon's free cash flow (FCF). Last quarter it made $21.4 billion in FCF over the last 12 months (LTM). That works out to 3.8% of its LTM revenue of $554 billion.
Using a 4% FCF margin and analysts' estimates of $635.7 billion in 2024 sales, we can forecast its free cash flow at $25.4 billion in the next year. We can use that to estimate a market price target for AMZN stock.
For example, if Amazon were to pay out all of this FCF as a dividend, the stock would likely sport a 1.5% dividend yield. That is based on comparisons with other stocks in size. In fact, some, like Microsoft (MSFT) have even lower yields (i.e., 0.81%).
Therefore, if we manipulate this yield, we get an implied market cap for AMZN of $1,693 billion. In other words, if AMZN stock has a $1.693 trillion market cap and it paid out $25.4 billion in dividends (i.e., all its forecast FCF), the stock would have a 1.5% dividend yield. That is the same as says AMZN stock has a 1.5% FCF yield.
This is 9.22% higher than its present market cap of $1,550 billion. Moreover, using a 1.0% FCF yield AMZN stock would have a market cap of $2,540 billion. That could just as easily happen. So, on average we can estimate in the next 12 months AMZN stock will end up with a $2,116 billion market value.
That implies AMZN will rise by 36.5% over today's market cap. This gives us a target price of $204.71 per share.
Shorting AMZN For Income
The problem is that Amazon still not does pay a dividend. So, shareholders might want to sell short near-term put options for extra income.
For example, in my last article, I recommended selling short the $140 strike price for expiration on Dec. 15. At the time, the premium received was $0.85 and the strike price was 4.57% below the spot price, i.e., out-of-the-money (OTM).
Those who did this made an immediate yield of 0.607% (i.e., $0.85/$140). Since the stock closed at $149.97 on Dec. 15, the short sellers had no obligation to buy the stock at $140.
This trade can be put on again. For example, for the Jan. 5, 2024, expiration period, which is 3 weeks away, the $144 strike price puts trade at $1.05 on the bid side.
That provides an immediate short put yield of 0.729% (i.e., $1.05/$144.00). Moreover, the strike price is almost 4% below today's price. That means that short sellers of these put options have room for the stock to fall in the next 3 weeks before they will be obligated to buy it at this strike price.
Moreover, if this trade can be repeated every 3 weeks, the annualized expected return (ER) is 12.4%. This is seen by multiplying 0.729% by 17x, as there are 17 periods of 3 weeks in a year.
Note also that short sellers can reduce their risk of having to buy the stock at $144 by shorting the $143.00 puts, $1 lower. That gives them OTM protection of 4.65%, but the yield-to-put is lower at 0.594%. The annualized ER is lower at 10.1% as well, although this is not much lower than the 12.4% ER shorting the $144 strike price.
The bottom line is that AMZN stock shareholders have a way to make extra income while they wait for the stock to rise to its significantly higher target price.
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.
