Nvidia Stock Is on a Tear Up 86% YTD - Pushing Its Put Premiums Sky High

Nvidia (NVDA) stock is up 86% YTD closing at $271.19 after ending 2022 at $146.14. It's also up over 3.2% in the last month. Nvidia's valuation is now high along with the level of its put option premiums.  Investors fear NVDA stock will tank when its earnings come out in mid-May. As a result, this is attracting short-put traders for income plays.

As things stand NVDA stock trades on a forward multiple of 60x earnings, a sky-high price-to-earnings (P/E) ratio. However, investors more or less already expect there will be no recession in its semiconductor business. In addition, analysts are likely already projecting huge earnings gains for the year ending Jan. 2025 (i.e., for 2024). 

For example, the average analyst forecast for the year ending Jan. 2024 is $4.53, and $6.06 for Jan. 2025. This implies EPS will rise over 33%, putting NVDA stock on a forward multiple of 45x, down from 60x for 2024.

These are nosebleed valuation multiples, but investors in NVDA stock are somewhat used to them. For example, Morningstar reports that the average forward multiple in the last 5 years has been 40x. Nevertheless, even by that standard, NVDA stock is likely overextended.

Taking Advantage of High Put Premiums

This has pushed its put option premiums very high. As a result, a popular strategy is to short out-of-the-money put prices in near-term expiration periods.

For example, Nvidia is likely to report its earnings around May 22, so we can look at the May 19 expiration period. There we see that the $250 strike price is very popular with over 10,000 contracts outstanding. In addition, the $240 strike price is also extremely popular, showing over 18,000 contracts in investors' hands.

NVDA Puts Expiring May 19, 2023 - Barchart - As of April 21, 2023

For example, the $250 strike price trades for $4.05 and the $240 strike price is at $2.34. The $250 strike price is 7.8% below Friday's price of $271.19, and the $240 strike price is further away at 11.5% below the spot price.

Moreover, this means that the investor in a $250 strike price short put can make 1.49% on a yield-to-spot basis (i.e., $4.05/$271.19), and 1.62% on a yield-to-strike basis (i.e., $4.05/$250). These equate to very high annualized returns, assuming they can be repeated over 12 months, of 17.9% and 19.4% respectively.

However, there is a very high risk that NVDA stock could easily fall 7.8% over the next 27 days, especially if investors decide to reduce its sky-high P/E multiples. 

As a result, investors have been shorting the $240 strike price, 11.5% away from the present price. This provides a lower set of yields, but they are probably less risky. For example, the yield-to-spot basis is 0.862% or 10.4% annualized, and the yield-to-strike basis is 0.975% or 11.7% annualized.

As a result, investors can decide if they want to be aggressive or conservative in shorting these popular strike levels. The $240 strike price is conservative and the $250 strike price is aggressive. 

Either way, this is a good way to take advantage of investors' fears about the overall valuation of NVDA stock ahead of its upcoming earnings in late May. This is because the near-term put premiums are very high at the present time, providing a unique income opportunity for short-put 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.