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Nvidia Inc (NVDA) stock has been treading water since releasing excellent earnings on Aug. 28, three weeks ago. However, analysts keep raising their price targets. This makes shorting out-of-the-money (OTM)put options a superb strategy.
The reason is that the market appreciates the powerful free cash flow (FCF) that Nvidia is gushing forth on a massive scale. As a result, price targets for NVDA stock are now over 25% higher than the stock price.
NVDA closed at $116.00 on Friday, Sept. 20, which was close to the $117.59 price on Aug. 29 after the results were released. It has been treading water. That makes it ideal for short-put traders, especially since NVDA stock is still undervalued.
I discussed this and analysts' price targets and my target value of $184 per share in my last Barchart article. The Aug. 30article, “Nvidia's Strong Free Cash Flow Could Push NVDA Stock Higher - Shorting Puts Makes Sense,” also shows an example of how to play this - shorting out-of-the-money puts in nearby expiry periods.
How The OTM Short Put Play Worked Out
It now makes sense to redo this short OTM put strategy. For example, in the article I suggested selling short the $113.00 strike price put option expiring on Sept. 20. On Aug. 30, NVDA was at $118.42, so this was over 4.2% lower or out-of-the-money.
Since NVDA stock closed at $116.00 (higher than the put option strike price) on Sept. 20, the $113.00 short-put contract expired worthless. That is great for the short seller. The short-put play produced a 2.74% yield, given the $3.10 received (i.e., $3.10/$113.00 = 2.74%). In addition, the short seller had no obligation to buy shares at $113.00.
Moreover, for existing shareholders, that $3.10 premium received more than offset the $2.42 unrealized capital loss (i.e., $118.42. - $116.00). Also note that even if NVDA fell to $113.00 during the three weeks to Sept. 20, the investor's breakeven price would have been $109.90 (i.e., $113.00-$3.10).
So, investors can redeploy their capital to “Sell to Open” another short-put contract. More on that below, but, first, let's review why NVDA stock still looks cheap here.
Analysts Keep Raising Their Price Targets
Since my last Barchart Aug. 30 article on Nvidia, analysts' revenue forecasts and price targets have risen incrementally. For example, Yahoo! Finance reports that 50 analysts now have an average price target of $145.22. That is slightly higher than 49 analysts' $142.75 average price target three weeks ago.
Similarly, Barchart previously reported that the mean target was $142.60 for analysts, and as of Sept. 20, it's at $148.82 per share. In addition, AnaChart.com, a site dedicated to tracking analysts' price targets (to determine how well they perform), now says 39 analysts have written recently on the stock and have an average $145.39 price target. That's up from three weeks ago when the same 39 analysts had an average target of $143.43 per share.
Note that this $145.39 price target represents an upside of $29.39 in NVDA stock over the next 12 months or +25.39%. One reason could be Nvidia's strong revenue and FCF outlook.
Strong FCF and FCF Margins Lead to Higher Price Targets
For example, Seeking Alpha reports that next year the average revenue estimate is $175.59 billion, up from $174.34 billion three weeks ago. Note that this is over $50 billion more than the $125.57 billion forecast for the year ending Jan. 2025.
As I noted in my last article, Barchart made 45% FCF margins in Q2. That is slightly lower than the FCF margin of 48.58% it made in the last 12 months (LTM) - i.e., $46.786b FCF/$96.3 billion in revenue, based on Seeking Alpha's LTM data.
Nevertheless, to be conservative, we can use this 45% FCF margin to estimate 2025 free cash flow. This results in an estimate of $79 billion in FCF next year (i.e., $175.59b x 0.45). That is slightly higher than the $78.45 billion I estimated in my Aug. 30 Barchart article.
Moreover, to be conservative, let's use a 2.0% FCF yield metric (I used 1.75% previously). That results in a market cap estimate over the next 12 months (NTM) of $3,950 billion (i.e., $79b/0.02). That is over $1 trillion higher than Nvidia's market cap today of $2.845 trillion (i.e., $3.95 tr/$2.84 tr-1 =+38.84%).
That implies that NVDA stock is worth 39% more, or $161 per share (i.e., $116 x 1.3884). This is slightly higher than analysts' price targets, but they are likely to keep raising their targets.
New OTM Short Put Play
Investors may want to short some Oct. 18 expiration out-of-the-money (OTM) puts, 4 weeks away. For example, the $108 strike price put contract has a high bid-side premium of $2.43 per put contract. That strike price is 6.90% below Friday's close but represents a put yield of 2.25% over the next month (i.e., $2.43/$108.00).
Moreover, less risk-averse investors may want to short the $110 strike price, over 5% below today's price of $116.00. The $3.00 premium represents a 2.727% yield to the short-put investor (i.e., $3.00/$110.00).
The point is that these puts offer the investor both extra income and a lower buy-in point should the stock fall to these strike prices. Keep in mind that the risk is actually much lower than it appears.
For example, the $108 strike price has a breakeven point of $108-$2.43 from the income received, or $105.57, which is 9% below Friday's $116.00 price. Similarly, the $110.00 short-put play has a breakeven point of $107, or $9 below Friday's close, i.e., -7.76% out-of-the-money.
The bottom line here is that NVDA still looks undervalued. Since put option premiums are very high, it makes sense to roll over the previous short-put play and take advantage of these high short-put yields.
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.
