Nvidia’s Undervaluation Presents Opportunity for Short Put Traders

Nvidia Stock

Nvidia Corp (NASDAQ:NVDA) has experienced a commendable surge in its stock value following its earnings report on Nov. 21. According to our model forecast, there is still potential for further growth in NVDA, allowing current shareholders to capitalize on this by selling short out-of-the-money (OTM) puts to generate additional income.

Reasons Behind NVDA’s Potential Upside

Nvidia recently disclosed a robust Free Cash Flow (FCF) of $7 billion, accounting for an impressive 38.9% FCF margin on $18.1 billion in Q3 revenue. This indicates that nearly 40% of all revenue, after accounting for various outflows including capital expenditure and changes in working capital, contributes directly to its cash reserves. The nine-month results show a consistent 40.5% FCF margin.

Utilizing this information, we can project the potential free cash flow for the upcoming year, providing a basis for valuing NVDA stock. Analysts surveyed by Seeking Alpha estimate a 54% increase in 2024 revenue to $90.66 billion. Applying a 40% FCF margin to this projection yields a substantial $36.3 billion in projected free cash flow for the next year.

NVDA’s Price Targets

Anticipating a doubling of Nvidia’s FCF from $17.5 billion to $36.3 billion by the end of 2024 suggests the stock could potentially double from its current value, setting a price target of $980 per share. Assuming Nvidia allocates its entire FCF as a dividend, a 2.0% dividend yield would indicate a market cap target of $1,815 billion, representing a 49.3% gain over its present $1.216 billion market cap.

Analysts also acknowledge this potential. For instance, Yahoo! Finance reports an average target price of $641.23 per share, signifying a 30% upside over the next 6 to 12 months. AnaChart.com’s survey aligns with this optimism, showing an average target of $589.61 per share among 38 analysts.

Generating Extra Income through Shorting OTM Put Options

Existing shareholders can seize an opportunity to be compensated while waiting for the stock to rise by shorting out-of-the-money (OTM) put options with near-term expiry dates. For instance, looking at the Jan. 12, 2024, expiration option chain, the $460.00 strike price puts offer an immediate 1.02% yield, trading at $4.70 on the bid side and sitting almost 6.50% below the current price.

This strategy not only provides a good downside protection of 6.50% but also an annualized expected return (ER) of 17.3%, assuming the trade is repeated every three weeks. Investors seeking less risk can opt for the $450 strike price, yielding 0.679%, equivalent to an annualized ER of 11.5%. This becomes an attractive option for shareholders awaiting the stock to reach its higher target price.

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