marvel technology (MRVL), a chip design company rather than a comic book brand, generates strong free cash flow (FCF) and high FCF margins. This effectively increases the valuation of MRVL stock by at least 26%.
For example, based on my analysis, MRVL stock is worth at least $87.43 based on its high FCF margin. This is 26% above today's price of $69.02.
Since earnings were announced on March 7, the stock price has fallen 19% from $85.09. The market is skeptical and the premium for put options is high. We expect the stock price to fall further. This makes short put plays lucrative for short sellers of out-of-the-money (OTM) puts.
short selling opportunity
We discussed this opportunity in our previous article three weeks ago on April 5th, when MRVL's stock price was $72.23.Marvell Technology put options have a high premium – worth shorting for bullish investors in MRVL stock”At the time, I proposed shorting an OTM put with a strike price 5% below the spot price of $68.00 with an expiration date of April 26th. The premium received was $1.72, and the short sellers' put yield on these puts was 2.53%. (i.e. 1.72/$68.00).
After all, MRVL closed at $69.03 on April 26th, as seen in Barchart's price history tab. This means the strike price remained out of the money. As a result, the short seller was not obligated to purchase his 100 shares with the cash set aside for this short sale (i.e., $6,800 per put contract sold short).
Also note that shorting a strike price significantly below the spot price leaves room for MRVL stock to fall without the allocation being triggered. However, even if something like this happens, the investor does not need to worry for two reasons.
Why shorting MRVL puts works
First, as pointed out in the article, the stock price is undervalued based on the exercise price. Based on the company's high FCF margin of 33.3%, it showed it was worth $87.43 per share. So, for example, it could generate FCF of US$1.77b based on analyst revenue forecasts of US$5.32b on sales this year. Additionally, FCF is projected to be $2.35 billion, based on a 2025 revenue forecast of $7.05 billion. Therefore, average FCF could exceed $2 billion over the next 12 months on a run-rate basis (NTM).
Using a 2.5% FCF yield metric, that means MRVL stock is worth between $80 billion and $82 billion. This is 25% to 26% higher than its current market value of $59.9 billion. This means the stock is worth $87.43 per share.
The stock could easily rebound if the company reports continued high FCF margins in its upcoming financial results ending May 2nd. That's why the short seller is willing to short his OTM puts below the spot price.
Another reason these puts are sold short is that the break-even price is significantly below the spot price. For example, $1.72 in premium income reduced the break-even price from $68.00 to $66.28. This was more than 8.2% below the spot price. As it turns out, investors have benefited from this additional income since MRVL stock has fallen.
So it makes sense to give this deal another shot.
Short OTM puts on MRVL stock again
For example, let's take a put expiration chain that ends on May 31st, 32 days from today. This represents a $2.29 premium per bidder put option contract for a strike price of $64.00, or 7.46% out-of-the-money (OTM), which is $5.16 below today's price.
This means that a short seller at this strike price would receive an immediate yield of 3.58% (or $2.29/$64.00). This is even higher than his previous short play of 2.53% with a small OTM width.
This means that a short seller with $6,400 secured at a brokerage could enter an order for a put contract “Open Sell” 1 expiring on May 31st and receive $229.00.
Additionally, if an investor could repeat this play one quarter every four weeks and earn $229 each time, the expected return (ER) would be $687.00. This equates to an ER of 10.73% for him in just 90 days.
This shows how profitable shorting these puts can be for short put investors.
The downside is that the stock price may fall further. In particular, if MRVL shares fall below the exercise price, unrealized capital losses may occur.
However, at least in this case, the break-even price would be $64.00 to $2.29, or $61.71 per share. This is 10.95% lower than today's price. Even if the stock price falls to this level, it remains a good entry point into Marvell Technology stock for long-term investors.
The bottom line is that MRVL stock looks cheap here, and short sellers of the put can expect a decent expected return.
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On the date of publication, Mark R. Hake, CFA, did not have (directly or indirectly) any positions in any securities mentioned in this article. All information and data in this article is for informational purposes only. For more information, please see 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.
