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Today a large tranche of out-of-the-money put options traded in Microsoft Corp. (MSFT) stock. This highlights the underlying value of MSFT stock and is essentially a bullish play by the investor shorting these puts.
MSFT is at $451.02 per share, up over 11.2% from its recent low of $405.57 on Nov. 5, just after its fiscal Q1 earnings release on Oct. 30.
I highlighted the underlying value of MSFT stock in a Nov. 6 Barchart article: “Microsoft Has Large Unusual Call Options Activity - Investors Bullish on MSFT Stock.”
Today's unusual put options activity shows a similar theme. It shows that a large institutional investor feels strongly that MSFT stock may be undervalued. This article will explain why.
Large OTM Put Activity
The Barchart Unusual Stock Options Activity Report today shows a large amount of out-of-the-money (OTM) put options traded for expiration in a near-term period. That implies that the the seller of these puts, who may have initiated the trade, has a good degree of confidence that MSFT may not drop in the next month and a half.
The report shows that almost 2,300 put contracts have traded for the Jan. 31, 2025, expiration period at the $425 strike price. This strike price is over $26 below today's trading price, so it is 5.77% out-of-the-money.
The midprice of these put option contracts is $4.78 per put contract. That means that the short-seller of these puts is making an immediate yield of 1.124% (i.e., $4.78/$425.00) over the next 44 days until expiration.
That is a very good yield for the short seller, implying an annualized expected return (ER) of 9.3%, assuming the same yield can be repeated over 8 times in a year.
Moreover, the investor shorting these puts must have strong confidence that MSFT stock won't drop over 7% to the breakeven price of $420.22 (i.e., $425-$4.78) over the expiry period.
Underlying Value of MSFT Stock
And why not? In my last Barchart article, I discussed how MSFT stock could be worth at least $548.88 per share. That was based on its strong free cash flow (FCF) and FCF margins and analysts' higher revenue estimates over the next two years.
That implies an upside of at least 9.3% in MSFT stock. For example, the analysis I used showed how Microsoft could end up generating $96 billion in FCF over the next 12 months (NTM). Using a 2.35% FCF yield valuation metric the market cap could rise to over $4 trillion (i.e., $96b / 0.0235 = $4,085 billion).
That is 21.7% over today's market cap of $3,357 billion. In other words, MSFT stock is worth +21.7% more than $451 per share, or $548.88 per share.
Moreover, since then, analysts have raised their price targets on MSFT.
For example, last month analysts surveyed by Yahoo! Finance had an average target price of $495.78 per share, but today the survey shows an average of $507.50. Similarly, AnaChart.com's prior survey showed a mean target of $467.90 and today it's at $511.06 for 37 analysts' price targets.
The bottom line is that MSFT stock looks like it is still undervalued based on its underlying FCF fundamentals as well as from analysts' price targets.
This could be why large investors are shorting these out-of-the-money (OTM) put options in MSFT stock today. They may already have a long position in MSFT stock and would be happy to own more shares at $425.00 should the stock fall to that price in the next month and a half.
Moreover, the 1.124% short-put yield is a good way to get paid while waiting for that to happen.
