How We’re Earning A 14%+ Yield Selling Puts On Circle Internet Group

Summary Circle enjoys a powerful, straightforward business model, as stablecoin adoption trends move in the right direction. However, the firm’s volatile revenue drivers and extended valuation make the stock look unattractive at this price point. Selling put options at $80 yields more than 14% annualized, while giving investors a huge 66% margin of safety. We think this trade appears optimal whether put sellers are assigned or not. Thus, our ‘hold’ rating. We have wanted to invest in Circle Internet Group ( CRCL ) for a very long time. The company’s stablecoin business is a crucial piece of the crypto ecosystem, and the firm’s simple, straightforward revenue model is idiotproof – something favored by all-time investors like Warren Buffett. Unfortunately, the company has been private for many years. Thankfully, that all changed two weeks ago, when the stock finally went public. In the IPO, CRCL indicated in the range of $27-$28 per share, opened at $64, and has since rallied in almost a straight line to more than $240 per share (as of writing). As a result, IPO investors are already sitting on a 780% return in the span of just a few short weeks. As the issuer of USDC , one of the largest and most trusted stablecoins in circulation, Circle occupies a unique position within crypto. The company’s infrastructure is built for regulatory compliance and transparency, and we think that revenues are set to grow substantially as stablecoins are more widely adopted amongst institutions. However, while the business shows long-term promise, the valuation appears incredibly difficult to justify at present. Coupled with the fact that revenues are heavily tied to macro-sensitive interest income, and we’re not comfortable taking the stock long at this level. That said, it doesn’t mean that you can’t get involved. For us, we like the idea of selling put options on the stock. The highly volatile shares produce a yield premium north of 15% (even on far out-of-the-money options), and this trade also retains the option to buy shares if they dip considerably. From both a price and yield perspective, selling puts appears to be an optimal use of capital. Today , we’ll outline CRCL’s strong fundamental outlook, touch on the extended valuation, and explain why we think selling deep out-of-the-money puts on the stock is the best opportunity available for growth and income investors alike . Sound good? Let’s dive in. Financials As we just mentioned, CRCL has long been a stock that we’ve looked forward to buying, primarily due to the company’s simple but effective business model. In short, CRCL issues stablecoins, digital currencies that are backed one to one by US dollars. In layman’s terms, the company allows users to deposit USD and receive ‘USDC’ back out. For institutions, they can directly interact with Circle via the ‘Circle Mint’ product, and for retail users they can deposit and redeem stablecoins through the Coinbase platform. It’s a similar process for Euros and EURC, which is CRCL’s other core stablecoin product: Circle.com From there, users can use stablecoins across the crypto ecosystem in a frictionless way, transferring money, lending, or spending in a variety of ways. As a quick aside, it’s probably important to mention that over the last decade, the crypto ecosystem has evolved from a market of speculation into a more institutionally-focused financial system that has been built from the ground up to facilitate quick and easy transfers of value. This includes more familiar functions, like lending, trading, and more. While this parallel financial system has some drawbacks, we think that overall, it works as an improvement to what we have now. This is due to the fact that fees for conducting basic tasks are often near zero, transactions are quicker, and the system is largely ‘free and fair’ for everyone. Simply put, crypto holds the promise of lower costs, quicker transactions, and full, global enfranchisement into the financial system. These functions provide real value. To be clear, some see this opinion as ‘ideological’, and there’s no guarantee that crypto will supplant traditional financial institutions (‘TradFi’). It’s just where we see things going. That said, with 10 more years of development, we think that crypto will stand to rival what we have now in terms of ease of use and functionality. Even in the current day, many big players are starting to see the benefits, if the recent reports about Amazon ( AMZN ) and Walmart ( WMT ) are any indication. Not only that, but last Wednesday, the United States Senate passed a landmark stable coin bill , which granted legitimacy to the cryptocurrency industry with considerable bipartisan support. Many think the bill will become law, and end the patchwork regulatory environment that has existed up to this point. As the result of a much firmer regulatory footing, we expect the stablecoin industry to expand rapidly given the potential we see for businesses to use digital currency transfers as a cheaper means of value exchange versus current payment rails that charge fees. From here, institutional adoption could explode, and it would not surprise us to see overall crypto stablecoin market cap move into the trillions by the end of the decade. With roughly one quarter of this market at present, CRCL could see USDC and EURC adoption accelerate, directly impacting the top and bottom line. Creating the financial infrastructure to facilitate these fiat and non-fiat transactions has taken CRCL a significant upfront investment, but now the company is in a strong technical position to scale. As far as we understand, there’s limited additional unit costs for issuing and redeeming larger and larger stablecoin amounts, and which means that scaling with significant operating leverage should be straightforward. In terms of actually making money, CRCL takes the USD reserves it holds and invests into treasury and other cash securities, pocketing the interest. As the amount of reserves scales, so too should the firm’s revenues. Stablecoin market cap is one revenue driver, but the other is interest rates, which we’re much less bullish on. Over the short-term, rates appear set to drop, if recent fed commentary is anything to go by. For Circle, this should lead to lower revenue on a relatively fixed cost base, which should shrink net margins considerably. Similarly, over the longer-term, we think there’s no issue with the scalability of the business model, but if CRCL always relies on rates to power and net profits, then we expect that results will be quite cyclical. As it stands, profitability already exhibits considerable volatility, which buttresses our point: Operating Income (Seeking Alpha) Altogether, this revenue setup has some advantages, but the cyclicality will likely command a lower multiple from the market. Valuation Speaking of the valuation, CRCL appears incredibly expensive at the moment. With a market cap of $52 billion (at writing), and only $1.8 billion in TTM month revenues, CRCL trades an expensive price sales ratio of 29x. Similarly, on the bottom line, CRCL sports positive net income of roughly $173 million for the last 12 months. While this number is positive, underscoring the potential profitability of the business model, it also means that the stock is trading it roughly 305x earnings. With the fed dot plot indicating that rates may move lower in the coming years, we don’t think CRCL’s stock will become meaningfully cheaper by the end of the decade: Bankrate Sure, reserves will likely grow, but with interest rates falling commensurately (damaging margins), there are serious headwinds to short and mid-term results. This makes the stock look very expensive, unlike other growth stories which are set to see their multiples shrink considerably in the coming periods. Thus, when you add up the company’s long-term opportunity, but meager short- and medium-term outlook, we think the stock should be avoided for now. The Trade So how can investors make money in CRCL? Just because the stock isn’t viable, doesn’t mean that we can’t get involved as sharp investors. The recent rally in CRCL’s stock has made the stock prohibitively expensive, but it’s also boosted the shares’ implied volatility, which means that option premiums are incredibly high, even for very low probability outcomes. In layman terms, this means that you can take advantage of the option market and earn a solid cash yield on your money, taking very little in the way of nominal risk. For reference, when you sell a put option, you make money if the stock stays above the strike price through expiry. If the stock price drops below the price before expiry, then you may need to buy the shares outright. This is called ‘assignment’. For CRCL, we’re looking at shorting the October 17th, $80 strike put options: Expiry / Strike (TradingView) These options are currently trading for $3.80, which means that for every contract you sell, your brokerage account brings $380 in cash. When you sell these options, one of two things can happen – either CRCL can stay above $80 over the next 117 days, or the stock can dip below $80 by expiry. If the stock stays above this strike price, then you get to keep the full cash amount you earned at the start. In this case, that means $380. Given that each contract requires 7,620 in margin to sell, this ‘yield’ works out to roughly 4.5%, which is 14.3% percent annualized. If the stock drops below the strike price of $80, then put sellers will likely be assigned the stock at $80 . While this may lead to a short-term unrealized loss, We think that getting CRCL at such a massive discount vs. the market represents a much better entry point into the long-term story. With an entry point at $80, assignment takes place at 9.5x TTM sales, which we think boasts a much stronger margin of safety. At the same time, even if assigned, you still get to keep the cash you brought in at the start of the trade, which comes out to a yield of 4.5% percent on capital (14.3% annualized), as we mentioned earlier. That way, no matter what happens, with this trade you’re ending up with a solid yield on your capital, and depending on what the stock does, you either get your margin back, or you get a new position in CRCL at a discount to where the stock is trading today. Given the fact that our core concerns about CRCL are short and medium term in nature, we think an entry point at 9.5x sales ameliorates a lot of risk. Thus, selling these options amounts to what we view as a win-win trade. Risks That doesn’t mean that there aren’t risks – because there are. On the option side, selling a put option means that you are liable even in the event that the stock drops to zero overnight. In that case, you’d still need to purchase shares at $80, even if they were functionally worthless. This isn’t a different risk profile versus holding the stock outright, but it’s worth thinking about. With CRCL, there’s always a risk that the company’s technology could fail or break in an unexpected way, that could lead to serious losses in confidence for Circle and USDC more broadly. Similarly, on the stock side, there are some risks that come with buying CRCL, even if assigned at a 66% discount versus today’s price. The chief risk again comes from the stock’s revenue profile, which is largely dependent on interest rates. Interest rates may not always be high, and as they move lower, it’s a headwind for shareholders, even with increasing adoption. Thus, we expect continued volatility in both the stock and the firm’s organic results. Summary Overall, we see CRCL as a risky proposition at the current price. However, getting assigned shares at $80, while earning an incredible 14.3% return on capital seems like a much better way to play the stock’s recent move. With long-term adoption trends intact, but short-term uncertainty, we see this trade as being optimal for all types of investors. Thus, our ‘ Hold ‘ rating on CRCL. Stay safe out there.

Source: Seeking Alpha