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Nvidia Inc (NVDA) stock still looks undervalued based on its powerful free cash flow and FCF margins. The company will release its earnings next Wednesday, May 22, for its fiscal Q1 2025 ending April 30. As a result, its put option premiums are now very high from speculators that expect NVDA to fall. That makes shorting out-of-the-money (OTM) puts attractive as an income play, especially for existing investors in the stock.
NVDA is trading at $908.34 in midday trading on Tuesday, May 14. However, the stock could still be undervalued here. I discussed this in my last Barchart article on April 21, 2024, “Nvidia Stock Looks Too Cheap Here - Put Premiums are Very High and Worth Shorting.”
Valuing NVDA Stock
In the article, I discussed how NVDA stock could be worth $942 per share based on its FCF and FCF margins. That was based on analysts' revenue estimates for this year and next that have since risen. Now Nvidia is on an average run rate revenue of $126.675 billion in the next 12 months, vs. $123.87 billion in the article.
As a result, using an average 47.5% FCF margin forecast, its FCF could rise to $60.2 billion in the next 12 months. That would be over twice the $26.95 billion it made in FCF last fiscal year.
Using a 44.4x multiple (the same as a 2.25% FCF yield metric) means that NVDA stock could end up with a market value of $2.673 trillion. That is 18% higher than the stock's existing market cap of $2.269 trillion.
In other words, NVDA stock could still be worth 18% more, or $1,070.86 per share. Many other analysts think NVDA is undervalued as well. For example, Barchart's survey of 38 analysts has a median target price of $966.46 per share. That is still 6.5% higher than today's price. In addition, AnaChart.com, a new sell-side analyst tracking service, says that the average of 38 analysts' price targets is $1,011.67.
The bottom line is that if the company keeps generating strong FCF margins, the stock looks cheap here. One way to play this, especially for existing investors, is to sell short out-of-the-money (OTM) put options to gain extra income.
Selling OTM Puts for Income
I discussed this in my last article - where I discussed shorting the $725 strike price puts due May 10 for $21.10 in premium, three weeks away. That option expired worthless, giving the short sellers an immediate yield of 2.91% in a strike 4.86% below the spot price. Since it remained out-of-the-money until expiration, there was no obligation to buy shares at $725.
This kind of play benefits existing shareholders who do these plays the most. They get the upside in the stock as well as the short-sale income. It's worth doing again.
For example, look at the May 31 option expiration period, 17 days from now. It shows that the $880 strike price puts, 2.8% below today's price, trade for $35.10.
This implies that a short seller of these puts can make an immediate yield of 4% (i.e., $35.1/$880.00 = 3.99%). This also provides good downside protection to the short seller. For example, the breakeven price is $880 - $35.10, or $844.90, which is 7% below today's price.
However, some investors may want to do a less risky short-sale play. The June 7 expiration period shows that the $860 strike price puts are trading for $30.75.
That provides an immediate yield of 3.58% (i.e., $30.75/$860) and the breakeven level is $829.25 or 8.7% below today's price.
The bottom line is that shorting OTM puts provides a good way to generate extra income in NVDA stock. This works well with NVDA stock since it is still undervalued. That means that even if the puts are exercised it would still be a bargain entry price for the investors who buy at the strike prices they shorted. They can hold the new shares until the stock reaches the expected target price.
And even if not, the breakeven levels provide extra downside protection. The investor can also turn around and short OTM calls to generate extra income if they think the stock will stay level for a period. This is why shorting OTM puts in NVDA stock looks like a good income play for existing investors.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
