Microsoft Corp (MSFT) showed strong revenue growth and FCF margins in its latest results for Q4. As a result, MSFT stock could be worth up to 25% more or over $500 per share based on FCF forecasts. This is good for short sellers of out-of-the-money (OTM) put options as an income play.

I discussed this in my last Barchart article on Jan. 31, “Microsoft Shows Strong Profit and Cash Flows, Making MSFT OTM Puts Worth Shorting.” For example, I suggested selling short the $390 strike price put for expiration on Feb. 16. At the time MSFT stock was at $402.91 and the stock closed at $404.06 on Friday, Feb. 16. Today it's at $401.08.

As a result, this trade worked out well since the short-put option play expired worthless. The investor was able to keep the $2.47 in income (i.e., 0.63% put yield). In addition, they also had no further obligation to buy the stock at $390 per share. That capital is now free to do another short-put play.

I will show another short-put play below. But first, let's review why MSFT stock could be worth substantially more.

Free Cash Flow Target Estimates

Whenever you short an OTM put option you want to make sure the underlying stock is worth substantially more than its present price. That gives impetus and a driving force to allow the stock to rise. As a result, it is less likely that the stock could fall to the point where the short-put investor has to buy the stock at the shorted strike price.

I like to set a price target using free cash flow (FCF) and FCF margins. For example, based on analyst estimates, Microsoft could generate as much as $83.7 billion in FCF sometime in the next 12 months (NTM). Based on that we can set a price target.

Our $83.7 billion FCF estimate is based on a 32% FCF margin and analysts' revenue estimates. Seeking Alpha's survey of 44 analysts shows that for the year ending June 30, 2024, revenue will reach $244.23 billion and for June 30, 2025, it will hit $278.98 billion. So its NTM revenue average is $261.6 billion.

Using a 32% FCF margin (see last article) means that Microsoft could be on a run-rate FCF estimate of $83.7 billion (i.e., 0.32 x $261.6b). Moreover, applying a 2.25% FCF yield metric (which is the same as multiplying by 44.44x) gives us a market cap estimate of 3,720 billion (i.e., $3.72 trillion). That is 25% over its present market cap of $2.98 trillion.

In other words, MSFT stock could be worth as much as $500.55 per share (i.e., 1.248 x $401.08 = $500.55). That gives existing shareholders good reason to short OTM puts for extra income.

Shorting OTM MSFT Puts for Income

For example, look at the March 15 expiration put option chain, which is a little over three weeks away (24 days). It shows that the $390 strike price puts trade for $4.05 on the bid side.

That represents an immediate income of 1.038% for the short seller (i.e., $4.05/$390.00) at a strike price that is about 3% below today's price.

For more conservative investors, the $385 strike price put, 4% out-of-the-money, trades for $3.00. That represents a 0.78% short put yield (i.e., $3.00/$385.00). In other words, there are good ways that investors in MSFT stock can make extra income by shorting these puts and waiting until they expire.

If MSFT stock falls to the strike price the investor's cash that was secured for the short put play will be used to buy shares at the strike price. That could lead to an unrealized capital loss. But at least the investor has the comfort of knowing that MSFT stock is worth substantially more.

Moreover, investors in MSFT and these short-put plays can always turn around and use the recently purchased shares (if the short-put strike price was exercised) in a covered call option play. That allows them to gain extra income that could make up for some of the unrealized loss.

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