Broadcom (NASDAQ:AVGO), the prominent semiconductor and software company, has been attracting investors with its substantial free cash flow profits. AVGO stock has become a favorite among investors, and presently, shorting out-of-the-money (OTM) puts appears to be a lucrative income opportunity.
In recent times, AVGO stock has shown a robust upward trend, currently trading at $885.23, a significant climb from $829.08 on September 22. Investors have recognized the stock’s undervaluation following the company’s recent earnings report on August 31.
Remarkable Free Cash Flow Margins Suggest Higher Target Price
A key point of interest is the extraordinary free cash flow (FCF) margins reported by the company for the fiscal Q3. For instance, in the quarter ending on August 31, the company generated $4.587 billion in FCF from $8.876 billion in revenue. This means that over half of its sales are translated directly into free cash, which can be allocated for dividends, share buybacks, acquisitions, and more.
These high FCF margins can be used to estimate the stock’s target value. Assuming a 50% FCF margin and applying analysts’ $38.74 billion revenue estimates for the fiscal year ending October 2024, the FCF could reach $19.37 billion for that year. Using a 5% FCF yield (equivalent to a 20x multiple), Broadcom’s market capitalization could potentially reach $387 billion, which is a 6.8% increase from the current market cap of about $362.7 billion. Furthermore, using a 4% FCF yield (25x FCF), the market cap could rise to $484 billion, suggesting a 33.5% potential upside. On average, this indicates a target valuation approximately 20% higher than the current stock price.
This implies a target price of $1,062 per share, reflecting a 20% increase from the current price of $885.23.
Enhancing Income Through Shorting OTM Puts
Previously, we recommended selling short put options with strike prices of $785 and $790 expiring on October 13. These plays turned out to be profitable as the stock closed at $883.13. Investors who engaged in this strategy received $7.80 and $8.60 in put income for yields of 0.99% and 1.088%, respectively.
Currently, near-term expiration puts also offer attractive premiums. For instance, the put options with strike prices of $835 and $840 expiring on November 10 have premiums of $11.05 and $12.20, respectively. This means investors can earn an immediate yield of 1.32% and 1.45%, respectively, by dividing the premium by the strike price.
In practical terms, an investor can put $83,500 in cash or margin with their brokerage and “Sell to Open” one put contract at the $835 strike price, expiring on November 10. This would instantly yield $1,105 in cash, which amounts to 1.32% of the $83,500 invested. If this strategy is repeated monthly for a year, the investor can anticipate a return of $13,260, which is 15.88% of the initial $83.5K investment.
Notably, the strike price is 5.42% out-of-the-money (OTM), offering downside protection for the short-put investor.
In essence, investors can generate income by shorting OTM puts while awaiting AVGO stock to potentially achieve its target price, which is based on its substantial free cash flow.
Please note that all investment activities involve risks, and it’s important to conduct thorough research and consult with a financial advisor before making any investment decisions.
Featured Image: Megapixl
Author Faith Yakubu 
