Amazon’s Strong Free Cash Flow Makes it a Good Candidate for Shorting Out-of-the-Money Puts

Amazon (NASDAQ:AMZN) has maintained resilience since February 1, supported by its Q1 results. With a robust free cash flow (FCF) outlook, AMZN stock could potentially be undervalued by over one-third, making it an appealing prospect for long-term investors who also engage in shorting out-of-the-money (OTM) puts for additional income.

Amazon’s strong free cash flow (FCF) was $36.8 billion for the trailing 12 months (TTM) ending December 31. This amounted to 6.40% of its TTM sales of $574.8 billion in 2023. Projections suggest that Amazon will continue to generate strong FCF, with analysts forecasting revenue to rise to $641.55 billion this year, marking an 11.6% increase over 2023. Additionally, surveys indicate a further uptick in revenue to $715.07 billion by 2025. Assuming an average run rate revenue of $664.8 billion in the next 12 months (NTM) and applying the 6.40% FCF margin from Q4 on a TTM basis, a forecast FCF of $42.55 billion can be derived for the NTM period, representing a 15.6% increase over the previous year.

Considering a hypothetical scenario where Amazon pays out 100% of its FCF to shareholders, the market cap could reach $2.836 trillion, representing a 51.2% increase over the current $1.875 trillion market cap. Even with a conservative 2.0% FCF yield metric, the projected market cap would be $2,127.5 billion, reflecting a 13.5% increase. This implies that Amazon could be worth between 13.5% and 51.2% more in the next 12 months, translating to a price target of $238.73 per share. Existing shareholders can capitalize on this opportunity by holding onto AMZN stock while selling short OTM puts for extra income.

For instance, shorting OTM puts with a $175 strike price for the April 19 expiration period, priced at $1.55 per contract, offers an immediate yield of 0.886%. Alternatively, the $170 strike price puts, trading at 67 cents per contract, provide a yield of 0.394%, albeit with a lower strike price almost 6% below the current price. Despite the risk, the breakeven price for the $170 strike puts is $169.33, making it less likely for the stock to reach that level, especially considering the identified price target for AMZN stock.

In conclusion, Amazon appears undervalued, presenting an opportunity for investors to leverage shorting OTM puts for additional income, particularly for existing shareholders looking to capitalize on the stock’s potential upside.