Dell Stock Has Very Attractive Short-Put Yields - Over 3.8% for the Next 2 Weeks

Dell Technologies (DELL) stock still looks undervalued, based on free cash flow analysis and analysts' revenue forecasts. Moreover, shorting 2-week puts at a 6% out-of-the-money (i.e., lower) DELL strike price yields over 3.8%. This article will show how this play works.

DELL closed at $392.32 on Thursday, July 2, off from a June 1 peak of $465.96 (i.e.,-15.8%), after its May 28 Q1 earnings release., But it's well up from May 27, when it closed at just $305.32 (+28.5%).

Higher FCF and FMV Estimates for Dell Stock

I have written two Barchart articles, showing what DELL stock could be worth (i.e., its fair market value or price target), as well as a strategy to play it: i.e., short one-month out-of-the-money puts. 

For example, in a June 1 Barchart article, “Dell Stock Could Be Worth 30% More - Based on Strong AI Demand and FCF,” I showed that DELL stock could be worth $544.47 per share. That was based on analysts' 2027 revenue forecasts on a 7.05% FCF margin, to reach a $13.0 billion FCF estimate. Next, after applying a 3.5% FCF yield metric (and discounting the price target by 5% for the time value of money), the fair market value (FMV) was estimated to be $371.4 billion. 

(Today, its market cap, according to Yahoo! Finance, is $254.79 billion.)

However, since then, analysts have raised their revenue forecasts to $190.31 billion, so using a 7% FCF margin, 2027 FCF would be:

  $190.31b x 0.07 = $13.32 billion '27 FCF

After applying a higher 3.70% FCF yield (i.e., multiplying FCF by 27x) (i.e., a slightly lower metric) and discounting it by 5%, the FMV is $341.7 billion:

  $13.32b x 27 = $359.64b x 0.95 = $341.658b FMV

That's almost $87 billion higher than today's market cap of $254.79 billion, or 34% higher. In other words, the price target (PT) is 34% higher than last week's close:

  $392.32 price x 1.34 = $525.71 price target (PT)

Analysts Agree DELL is Undervalued

Analysts have raised their PTs in the last 2 weeks. For example, in my June 16 Barchart article, “Dell Stock Looks Cheap Here With Higher Analyst Forecasts - Short Put Plays Are Attractive,” Yahoo! Finance reported that the average of 27 analysts was $483.83. Now, that average is up to $485.09. 

That PT is 23.6% over last week's closing price. Similarly, Barchart's mean analyst survey PT has risen from $485.95 to $486.86, which represents a 24% upside for DELL stock.

The bottom line is that, either based on its future FCF estimates or analysts' price targets, DELL still looks very cheap.

However, as I pointed out in my last Barchart article, there is no guarantee that DELL stock will rise right away to that PT. So, one way to set a lower buy-in is to sell short out-of-the-money (OTM) puts in nearby expiry periods.

Shorting OTM DELL Puts for High Yield and Lower Buy-In

For example, in my June 16 Barchart article, I suggested shorting the $370 put option strike price contract that expires on July 17. At the time, that was about 9.5% below Dell's price, and it sold at a $18.20 premium. That gave short-put investors a one-month yield of 4.92% (i.e., $18.20 / $370.00).

Today, that premium has fallen to $14.18 at the midpoint. So, for the next two weeks, an investor can still make a 3.83% yield (i.e., $14.18/$370.00). This can be seen in Barchart's July 17 option chain table below:

This strike price is just over 6% below the closing trading price (i.e., out-of-the-money), so, there is no danger just yet that the investor's collateral would be assigned to buy 100 shares at $370.00. However, the delta ratio is fairly high at -0.3151, implying over a 31% chance that DELL could drop to $370 in the next two weeks.

Nevertheless, even if the account is assigned at $370, the net breakeven point is much lower:

  $370 - $14.18 income already received = $355.82 breakeven buy-in point

That is 9.76% below last week's closing price, so it provides a good entry point for value investors.

However, it might make more sense for new investors to short a one-month out DELL put at a lower strike price. Look at the table below.

It shows that for the Aug. 7 expiry period, a lower $360 strike price put option, with a similar delta ratio (i.e., risk of assignment), has a higher premium of $22.73.

That gives the investor a higher short-put yield for the same risk:

  $22.73 / $360.00 = 6.3139% one-month yield. Granted, that is lower than repeating the 3.83% 2-week short-put play above (i.e., 3.83% x 2 = 7.66%). But, the strike price is lower, i.e., 8.70% below today's price, and the net breakeven point is much lower:

  $360.00 - $22.73 = $337.27 breakeven, i.e., -14.5% below today's price

As a result, either of these two short-put plays is very attractive to value investors. 

For example, if an investor can repeat this one-month 6.3% short-put yield for the next 6 months, the expected return (ER) is 37.8%. That is higher than my 34% higher-price-target expected return over the next year. (Note that there is no guarantee an investor can repeat this one-month short-put yield each month for the next six months.)

The bottom line here is that DELL stock looks deeply undervalued. Since its two-week and one-month put option premiums are very high, it makes sense to short them to make high yields.