Netflix Stock Is Close to Fair Value – Shorting Options Is the Best Strategy Here

Netflix Inc (NFLX) stock has risen a good deal recently. It’s close to the prior target price of $714, now revised to $809 (see below) based on analysts’ forecasted revenue hikes. Selling short out-of-the-money puts and calls is an ideal way to play this. 

NFLX closed at $701.35 on Friday, Aug. 30, up significantly from a recent low of $598.55 on Aug. 5. This is close to my price target of $714, described in my July 19 Barchart article.

I also described a short-put strategy in my Aug. 9 Barchart article, “Netflix Stock Is Up From Its Lows, But Its Put Option Premiums are Still High – Short Them.”This article will update Barchart readers on a new NFLX price target and the short-put and call option strategy.

Revised Free Cash Flow Projections

In my prior analysis, I noted that the company’s lower free cash flow (FCF) compared to last quarter still worked out to between 17.7% of sales in H1 2024 and 12.69% in Q2. Moreover, management has said it expects to make $6 billion in free cash flow (FCF) this year.

That works out to 15.76% of analysts’ revenue forecast this year of $38.07 billion. So, on average, going forward can can estimate roughly 16% FCF margins (although in Q2 it was lower).

Here is why this is important. Next year analysts project revenue will reach $43.42 billion. Applying a 16% margin means that FCF could rise to almost $7 billion (i.e., 0.16 x $43.42 billion = $6.95 billion). This is +15.8% higher than this year than management’s forecast of $6 billion this year.

Revised Price Target for NFLX Stock

The NFLX stock’s price target can be set using an FCF yield metric. For example, NFLX stock is trading on a 2.0% FCF yield right now (i.e., $6b FCF/ $301 billion market cap = 0.02). Therefore, if we use next year’s forecast of $6.95 billion in FCF and divide it by 2.0%, the resulting market value should rise to $347.5 billion. That is 15.4% higher than today.

In other words, NFLX stock is worth +15.4% more, or $809 per share (i.e., $701.35 x 1.154 = $809.36). 

Analysts also have higher price targets for NFLX stock as well. For example, AnaChart, a new sell-side analyst tracking site, shows that the average of 35 analysts is $736.91 per share. That is over 5% higher than today’s price.

This is lower than my revised price target and is closer to today’s price. As a result, it might make sense here to sell short out-of-the-money (OTM) put options.

Shorting OTM Puts and Calls

In my last article, when NFLX stock was at a low I suggested shorting put options that expired on Aug. 30 (3 weeks away) at the $600 and $610 strike prices. These plays have all expired worthless, and the existing NFLX shareholder at the time would have made the best of two plays – an income play and an upside in NFLX stock. 

For example, the $610 strike price provided a $10.05 premium or $1,005 on the $61,000 invested in that play, a yield of 1.6475%. Given that the stock was at $632.35, this play was 3.53% below the stock, i.e., 3.5% out-of-the-money. Moreover, if the investor already owned NFLX stock, it has risen 10.9% from $632.35.

Today, it makes sense for existing shareholders to consider shorting covered calls (i.e., selling calls at higher out-of-the-money (OTM) prices). For example, look at the Sept 20 expiry period, three weeks from today.

The Barchart table below shows that the $735 strike price, which is 4.80% higher than the Friday, Aug. 30 price of $701.35 (i.e., out-of-the-money), has a price of $4.08. That provides the covered call investor an immediate yield of 0.58% (i.e., $4.08/$701.35).

That means that unless the stock rises to $735 or higher in the next three weeks, the covered call investor has no obligation to sell his shares at that strike price. They also get to keep any upside in NFLX stock up to $735 over the next three weeks. In effect, the investor makes $405 on an investment of $70,135 (i.e., $701.35 price today x 100).

Nevertheless, since the shareholder may already own NFLX shares, the covered call yield could potentially be higher. This would be based on the investor’s buy-in cost (as the denominator).

However, a short-put strategy here could produce higher income for investors. For example, the $670 put strike price has a premium of $4.70. That strike price is 4.47% out-of-the-money (OTM), close to the 4.80% OTM call strike price distance. 

This short-put play provides a higher income yield of 0.70% (i.e., $4.70/$670.00 = 0.007). Moreover, the short put investor has to secure just $67,000 (i.e., $670 x 100), rather than the $70,135 required for a covered call play today.

But if the investor already owns shares in NFLX stock, they will also gain any upside in the stock. So, it might make sense to short OTM puts rather than calls. However, this will require an additional investment of $67,000 per put contract shorted.

The bottom line is that NFLX stock is still undervalued. One way to play this is to sell short out-of-the-money puts and calls in nearby expiry periods.

More Stock Market News from Barchart

On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.