Nvidia Corp. (NASDAQ:NVDA) boasts remarkably high free cash flow (FCF) margins, which could drive its stock to even greater heights. In the meantime, taking advantage of the elevated premiums on out-of-the-money (OTM) put options seems like a smart move for additional income.
Free Cash Flow’s Potential Impact on Nvidia Stock
It’s argued that NVDA stock’s value could range between $581.26 and $780.53 per share, primarily driven by its robust free cash flow. This translates to an average price target of approximately $680.90 per share.
To exemplify Nvidia’s FCF prowess, in the most recent quarter ending on July 31, the company generated over $6 billion in FCF. This impressive figure represented an astonishing 44.8% FCF margin based on quarterly revenues of $13.5 billion.
Looking ahead, Nvidia is expected to produce revenue of up to $16 billion in the upcoming quarter, potentially raising its FCF to approximately $7.17 billion. This has significant implications for the valuation of NVDA stock.
Analysts’ projections indicate that revenue will reach $54.08 billion for the year ending on January 31, and $79.39 billion the following year. Over the next 12 months, the average revenue could be around $66.7 billion. Utilizing a 45% average FCF margin suggests that free cash flow could surge to $30 billion, potentially driving NVDA stock to higher levels.
For instance, at a 2.0% FCF yield (equivalent to multiplying FCF by 50x), the market capitalization could reach $1.5 trillion, which is 35% higher than Nvidia’s current $1.11 trillion market cap. In other words, NVDA stock could rise to $616.76, representing a 35% increase over its current price of $456.86 per share.
Shorting OTM Puts as an Income Strategy
While investors await this potential growth, it makes sense to capitalize on the elevated premiums of OTM put options by selling them short. This strategy generates additional income, particularly for investors who already hold NVDA stock. Notably, there is no risk of having the stock called away. The primary risk is a decline in the stock’s price, which might necessitate the purchase of more shares and potentially create an unrealized loss. However, it could also lower the overall dollar cost of holding the stock.
For instance, let’s consider the expiration period ending on November 24, just three days after the company reports earnings on November 21 for the quarter ending on October 30. This is less than three weeks from today, but the premiums for put options are substantial.
An example is the $430 strike price, which is over 5% below the current price, making it an OTM put. The bid price for this option is $12.40, offering a 2.88% yield on the $430 strike price for short sellers. This high yield over a short period is appealing. If this strategy can be repeated every three weeks for a year (17 times), the annualized expected return amounts to 49%.
In practical terms, an investor sets aside $43,000 in cash and/or margin with their brokerage firm. They then “Sell to Open” 1 put contract at the $430 strike price, expiring on November 24. The investor immediately receives $1,240, equivalent to the bid price multiplied by 100. This amount is retained regardless of whether NVDA stock remains above $430 per share by November 24. Even if the stock drops to $430, the breakeven price for the investor is $417.60 ($430 – $12.40), which is 8.5% below the current price.
By repeating this trade every three weeks for a year, the account would accumulate $21,080, representing a 49% return on the $43,000 invested in this strategy over the year. Additionally, if the investor also holds NVDA stock, they might benefit from any potential upside in the stock, aligning with the discussed price target.
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