The valuation of Oracle Corp (NYSE:ORCL) stock remains appealing for value-oriented investors, underpinned by its reasonable 20x forward price-to-earnings (P/E) ratio and robust free cash flow generation. Despite recent stability in ORCL stock’s performance, this presents an opportune moment for executing short out-of-the-money (OTM) put options.
For instance, on Friday, August 11, ORCL closed at $113.06 per share, marking only a modest 4.1% decline from its end-of-July close at $117.91. This scenario allows traders engaging in short OTM put strategies to capitalize on additional income potential within the context of near-term expiration strategies.
A Noteworthy Free Cash Flow
In a specific instance, it’s noteworthy that Oracle’s fiscal Q4, concluding on May 30, resulted in a trailing 12-month (TTM) free cash flow (FCF) of $8.47 billion. This reflects a substantial 68% increase from the $5.028 billion TTM FCF generated in the preceding year. This growth can be attributed to Oracle’s advantageous positioning within the realm of cloud spending expansion and AI-driven initiatives.
This achievement translates to a 16.9% FCF margin, calculated based on the company’s fiscal 2023 TTM revenue of $50 billion. With this trajectory, Oracle’s future is poised to witness continued robust FCF generation. Analysts polled by Seeking Alpha anticipate revenue to reach $54.11 billion by May 2024, reflecting an 8.2% rise from the preceding year’s $50 billion. Extrapolating a 17% FCF margin to this revenue projection could result in an FCF estimate of $9.2 billion.
Positioned against its $307 billion market capitalization, this FCF projection corresponds to approximately 3.0%. It’s worth noting that technology stocks of this nature typically trade with FCF yields ranging from 2% to 3.33%. This corresponds to valuation metrics between 30x and 50x FCF.
Hence, a reasonable projection might position ORCL stock around 40x FCF, equating to approximately $368 billion (40x $9.2 billion). This projection implies a potential 20% upside (i.e., $368b/$307b-1), potentially propelling ORCL stock to $135.62 (20% higher than $113.06).
A Prudent Approach: Shorting OTM Puts
To tactically navigate this landscape, one strategy involves the shorting of out-of-the-money (OTM) puts while concurrently holding ORCL stock. As a practical illustration, traders can consider selling short on September 1, 2023, expiry puts at a strike price of $109, yielding a premium of $1.19 per contract. Notably, this strike price lies 3.59% below the current spot price of $113.06 per share, based on the August 11 closing price.
This approach involves allocating $10,900 or more to a brokerage account, utilizing a combination of cash and potential margin. Subsequently, an order to “Sell to Open” one put contract at $109 per share is executed, resulting in an immediate credit of $119.00 to the brokerage account.
Yield and Potential Returns of OTM Put
This transaction yields an approximate return of 1.09% ($119/$10,900 invested) over a mere 3-week period until expiration. If this strategy can be repeated every 3 weeks, it equates to an annualized return of 18.53% (1.09% x 17x).
Although there exists the inherent risk of ORCL declining to or below $109 before September 1, investors can still circumvent this scenario by not liquidating their ORCL shares. Instead, they would utilize the $10,900 to acquire 100 shares at $109 per share. This might lead to an unrealized loss but could also potentially lower the average cost for the investor.
To mitigate this risk, a more conservative approach could involve shorting puts with a strike price of $108 or even lower. At a striking premium of $0.97, this corresponds to a reduced premium yield of 0.90% ($0.97/$108).
Furthermore, it’s noteworthy that even if the short put strategy leads to exercise, investors have the option to execute “covered call” plays by shorting OTM calls. This strategy can contribute to offsetting potential unrealized losses.
Conclusion
In summary, the substantial free cash flow generated by Oracle (NYSE:ORCL) positions its stock for considerable upside. One viable and conservative strategy to capitalize on this potential is through the utilization of short OTM put options to generate supplementary income.
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