Today, large volumes of short-term put options in Advanced Micro Devices (AMD) stock imply that it might be overvalued. But a closer look at its strong free cash flow (FCF) and FCF margins could lead to a higher AMD price target over the next year.

AMD is at $260.40 today, up today, despite lower tech prices in the same sector. Since the company released its Q3 earnings on Nov. 4, AMD has risen over 4% from $250.05.

So, why the heavy put options volume? This can be seen in today's Barchart Unusual Stock Options Activity Report. It shows that four different tranches with different expiry and strike price put options have had heavy and unusual volume:

For example, the $252.50 put option contract expiring this Friday, Nov. 14, has shown over 15,000 contracts traded. That is 22x the prior number of contracts outstanding. This put exercise price is well below today's price, so it is out-of-the-money (i.e., the stock has to fall before there is any intrinsic value).

Two other put contracts expire on Friday as well, but they are closer to the money or slightly in-the-money. This implies that buyers of these puts are taking very short-term positions, hoping that AMD stock will pop lower.

On the other hand, short-sellers of the OTM put contract receive $2.76 for an obligation to buy shares at $252.50. That gives them an immediate yield of 1.09% (i..e, $2.76/$252.50) for just two days until expiration.

Moreover, their breakeven point is below $250 (i.e., $252.50 - $2.76 = $249.74), which is 4% below today's trading price. That works out to a very good expected return for a short-seller of these puts.

So, is AMD stock really overvalued here? These put contracts seem to imply that. But let's look closely at the company's recent earnings, and especially its strong free cash flow (FCF).

Higher FCF Margins 

AMD reported on Nov. 4 that its revenue rose 36% Y/Yand up 20% Q/Q. More importantly, due to operating leverage, its free cash flow (FCF) skyrocketed.

For example, FCF hit $1.53 billion, up 2x from $496 million a year earlier and even +29.7% higher than the prior quarter.

Moreover, this high level of FCF represented 16.55% of its quarterly revenue of $9.246 billion. That was better than the prior quarter's 15.35% FCF margin.

In other words, as revenue rises, the proportion of that revenue that flows straight into its checking account with no cash expenses associated with it rises even more. That is due to operating leverage - i.e., lower fixed costs with higher revenue lead to accelerating cash flow.

That implies that over the next year, its FCF margin could rise further, as revenue is expected to rise further.

For example, analysts now project that revenue next year will rise to $44.15 billion, up from $41.3 billion as I reported in my last Barchart article on Oct. 8.

That means that if the company can average at least 17% FCF margins next year, its 2026 FCF could rise to over $7.5 billion:

  0.17 x $44.15 billion 2026 revenue = $7.5055 billion FCF

Higher Valuation Based on FCF Yield

That could significantly raise AMD stock's valuation.

For example, Nvidia presently trades on a 1.59% FCF yield metric, as I showed in my recent Barchart article on Nov. 9.

So, if we apply that metric to AMD, its valuation over the next year could be as much as $443.7 billion:

  $7.055b / 0.0159 = $443.7 billion mkt value

That is 4.89% higher than AMD's market value of $423 billion today, according to Yahoo! Finance.

But if AMD achieves even a slightly higher FCF margin of 20% (after all, Nvidia made a 43.9% TTM FCF margin), AMD's valuation could soar:

  0.20 x $44.15 billion revenue = $8.83 billion FCF
  $8.83b FCF / 0.0159 = $555.35 billion market cap

That is +31.2% higher than today's market value of $423 billion.

In other words, just a 3-point improvement in its FCF margin (i.e., a 17.6% higher margin - 3%/17%), could lead to a 31% upside in its stock price:

 1.312 x $260.40 = $341.65 price target

The point is that AMD could still be undervalued here, anywhere from +4.89% to 31.2% higher, or +18% on average. That means its expected price target is over $300 per share

  1.18 x $260.40 = $307.27 average price target

So, for the short term, buying puts in AMD stock might work. But, for the long term, if AMD continues to improve its FCF margin performance with higher revenue, the stock looks undervalued.  

More news from Barchart

• Heavy Put Option Activity in Advanced Micro Devices Implies AMD Stock Is Overvalued - But Is It?
• Bullish Tilt: Palantir Option Strategy Geared for Upside Gains
• Enovix (ENVX) Offers the Most Daring Contrarians a Quant-Driven Upside Opportunity
• Alphabet Generates Strong FCF and If It Continues GOOGL Stock is 40% Undervalued