PayPal Holdings (NASDAQ:PYPL) has attracted attention due to significant call options activity, signaling potential undervaluation. This surge in activity may be linked to the company’s recent Q3 earnings report, revealing substantial adjusted free cash flow (FCF). Given its robust FCF margins, PYPL stock could be undervalued by over 50%, driving the heightened call option interest.

For November 15, over 9,000 call option contracts were traded at the $60 strike price, slightly above the spot price of approximately $58.00. These medium-term expiration calls, expiring on December 29, 2023, are close to the money, indicating a bullish stance by investors. Notably, this volume is over 38 times the normal outstanding call contracts at this strike price.

For a profitable trade, the stock needs to rise to $61.78, factoring in an average premium of $1.78 for the calls. This implies a modest 6.5% increase in PYPL stock within the next 44 days for a breakeven trade. However, the substantial volume suggests that long-call buyers anticipate a more substantial rise in PYPL stock.

The optimism around PYPL stock is fueled by its robust adjusted free cash flow (FCF) and FCF margins. In Q3, PayPal generated $1.9 billion in adjusted FCF with a remarkable margin of 25.6%, surpassing its operating margin of 15.7%. The impressive performance stems from a 15% YoY growth in total payment volume (TPV) and an 11% increase in the total number of transactions.

Analysts project revenue for 2023 to reach $29.6 billion and $32.2 billion in 2024. Applying the latest FCF margin (26%), an estimated $8 billion in FCF suggests a potential market cap increase to $114 billion, representing an 87% rise from the current $61.1 billion. Even with a conservative 10x FCF multiple, the stock could be worth $80 billion, indicating a 31% increase.

Taking the average of these estimates, PYPL stock could be valued at $92 per share, reflecting a substantial upside potential. This analysis offers insights into why investors are actively engaging in PYPL call options today.

Featured Image: Unsplash @ Marques Thomas

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