Netflix (NASDAQ:NFLX) stock has experienced a notable decline from its recent highs, currently trading at $374.31 as of October 6. This is well below its September 11 peak of $445.36 and the year-to-date high of $477.59 on July 19. However, the stock’s current valuation offers an attractive opportunity for value investors.
Investors have high expectations for Netflix’s upcoming third-quarter results, set to be released on October 18. This optimism stems from the company’s substantial free cash flow (FCF), which could have a positive impact on the stock. One strategy that could be considered, particularly for income-oriented investors, is selling short out-of-the-money (OTM) put-and-call options with near-term expiration periods.
Netflix’s Impressive Free Cash Flow
Netflix’s impressive FCF was highlighted in a previous article on September 15. In the first half of 2023, Netflix generated over $3.46 billion in FCF, with Q1 contributing $2.117 billion and Q2 contributing $1.339 billion. Comparatively, in the same quarter the previous year, Q3 FCF was just $472 million. Therefore, any Q3 FCF figure above $1.0 billion would signify significant progress, especially in light of new pricing strategies and potential disruptions from actors’ and writers’ strikes.
Additionally, analysts are closely monitoring Netflix’s FCF margins. Last quarter, these margins exceeded 21% for the first six months of the year. This metric is vital because if Netflix maintains or increases these margins, it could drive the stock’s upward trajectory.
Analysts’ projections for Netflix’s revenue next year indicate a growth of over 13% to $38.23 billion. By applying the 21% margin to this forecast, the expected FCF for the year could reach $8.0 billion. With a 4.0% FCF yield, Netflix’s market capitalization could expand to $200 billion, potentially representing a more than 20% increase from its current market cap of $166 billion. This implies a stock value of over $451 per share.
Generating Income Through Shorting OTM Put and Call Options
Investors looking to generate income can consider selling short OTM put and call options. For example, they can sell OTM call options, such as the October 27 call options with a $405 strike price, currently trading at $8.28. This allows investors to earn a 2.19% covered call yield with just three weeks to expiration. If the stock reaches the $405 strike price and the investor has to sell their shares at that price, they retain an additional 7.85% realized gain, resulting in a total potential return of 10%.
Alternatively, investors can explore $400 call options trading at $9.70, offering a 2.57% covered call yield over three weeks and a potential 6.52% realized gain or a total potential return of 9.09%.
Another strategy is to sell OTM put options as the October 27 puts with a $350 strike price, trading at $9.35 per put. This provides a higher yield of 2.67%, as the investor only needs to risk $350 per contract. Unlike covered calls, put sellers have no obligation to purchase stock, even if the stock’s price decreases.
In summary, Netflix’s stock appears poised for growth, making it a favorable choice for value investors. Selling either covered calls or cash-secured puts could be suitable strategies for income-minded investors seeking to capitalize on this opportunity.
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