McDonald’s Corp. (MCD) stock has recently tumbled based on widespread market fears regarding how elevated gas prices may have negatively affected consumer discretionary spending and overall sales. However, this bearish sentiment may have been heavily overdone, especially now that gas prices are experiencing a downward trend. A closer look at the company’s underlying financial health reveals a compelling value proposition. This article explores advanced ways to play MCD stock using a combination of out-of-the-money puts and in-the-money calls to maximize potential returns.
Market Context and Price Action
MCD closed at $269.76 on Friday, June 26, showcasing a modest recovery from a recent trough of $264.54 recorded just a day prior on June 25. Moreover, the current valuation remains well below its 3-month peak of $311.36 established on April 17. The current discount provides an attractive entry point, as our fundamental analysis indicates that based on its robust free cash flow (FCF), MCD stock could still be worth almost $300 per share, representing an 11% higher upside from current levels.
Free Cash Flow (FCF) Valuation Model
When calculating the true intrinsic value of McDonald’s, Free Cash Flow remains the ultimate metric. Financial analysts project the company’s revenue to land at $28.5 billion this year and expand to $30.17 billion next year. This averages out to approximately $29.335 billion over the next 12 months (NTM).
Applying the company’s trailing 12-month FCF margin of 26% to this projected revenue, McDonald’s Corp. could generate a massive $7.63 billion in free cash flow. If we apply a conservative 3.6% FCF yield to value the firm ($7.63 billion / 0.0359), we arrive at a fair market value (FMV) of $212.5 billion. This FMV is 10.6% higher than Friday’s market cap calculation of $191.7 billion. Mathematically, multiplying the $269.76 price by this 1.109 premium gives us a precise price target of $299.16.
It is worth noting that other major financial institutions and analysts hold even higher price targets for the fast-food giant. For instance, Yahoo Finance features an average analyst survey price target of $330.94, Barchart sets it at $330.59, and AnaChart leads with a highly bullish $351.90.
Strategic Play 1: Shorting Out-of-the-Money Puts
Because there is never a guarantee that MCD will immediately hit these elevated price targets, options strategies can be deployed to manage risk and generate yield. One highly effective method is to sell short one-month out-of-the-money (OTM) puts. This allows an investor to set a lower potential buy-in price while collecting premium income.
For example, looking at the $260.00 put option strike price expiring July 31, we see a midpoint premium of $3.08 per put contract. This strike price is comfortably 3.6% lower than Friday’s close for the next 34 days. To execute this, an investor posts $26,000 as collateral with their brokerage firm to secure the position (covering the obligation to buy 100 shares at $260.00). The account immediately receives $308.00 in income, representing an immediate yield of 1.185%. Even if MCD falls to the strike price and the shares are assigned, the net breakeven buy-in effectively becomes $256.92 ($260.00 – $3.08), which is 4.76% below Friday’s close.
Strategic Play 2: Financing In-the-Money Calls
For investors looking for leveraged upside without tying up massive amounts of capital long-term, the income generated from shorting puts can be used to finance the purchase of a long-dated, in-the-money (ITM) call option.
If an investor successfully repeats the short put strategy over six months, the cumulative potential income would be $18.48 per share ($3.08 x 6). This capital can fund the purchase of the Dec. 18, 2026, expiry $260.00 call option, which currently commands a midpoint premium of $23.98. Subtracting the $18.48 in generated put income brings the net cost of this call option down to just $5.50. This creates a net buy-in point of $265.50—well below the current trading price of $269.76.
If MCD reaches our calculated price target of $299.16, the $260.00 call will hold an intrinsic value of $39.16 ($299.16 – $260.00). Factoring in the low $5.50 net cost of the trade, the return on invested capital equals a staggering 612% profit ($39.16 / $5.50 – 1). This clearly illustrates the power of combining OTM puts and ITM calls for a highly leveraged, risk-adjusted investment in an undervalued blue-chip stock.
Frequently Asked Questions (FAQ)
- What is Free Cash Flow (FCF) yield and why is it used?
FCF yield is a financial solvency ratio that compares the free cash flow a company generates against its market value. It is highly valued by investors because it cuts through accounting adjustments to show exactly how much raw cash a business produces relative to its valuation. - What are the risks of selling out-of-the-money (OTM) puts?
When you sell an OTM put, you collect an upfront premium but take on the obligation to buy 100 shares of the underlying stock at the strike price if it falls below that level by expiration. The main risk is that the stock price crashes significantly below your breakeven point, resulting in unrealized losses on the acquired shares. - How does an in-the-money (ITM) call option provide leverage?
An ITM call option gives you the right to buy a stock at a specified strike price that is already below the current market price. It allows you to control 100 shares of the stock for a fraction of the cost of buying the shares outright. As the stock price rises, the option’s value increases at a much higher percentage rate compared to the underlying stock, amplifying your potential profits.
