Exploring Nvidia’s Upside: Analyst Insights and Strategic Options Plays

TipsForTraders | May 7, 2024

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Despite the continued ascent of Nvidia Inc. (NVDA) stock, there remains a compelling argument for its undervaluation based on revised financial forecasts and robust free cash flow (FCF) projections. The technology giant, known for its dominant position in the graphics processing market, has seen its shares surge 3.5% today to $918.44, yet analysis suggests a valuation exceeding $1,000 per share is justified.

Analysts are bullish on Nvidia, projecting a significant increase in revenue and FCF over the next twelve months. Estimates indicate that Nvidia could amass $62.5 billion in FCF based on expected revenues of $112.07 billion this year and $137.81 billion the following year. These forecasts rely on an anticipated FCF margin of 50%, slightly below the 51% achieved last quarter. Applying a 2.25% FCF yield to these figures implies a potential market capitalization of $2.78 trillion for Nvidia, marking a 21% increase from its current valuation of $2.294 trillion.

The high valuation has not gone unnoticed in the options market, where elevated put option premiums reflect ongoing investor apprehension about the stock’s lofty price tag. This situation has crafted an attractive scenario for investors to engage in short-selling out-of-the-money (OTM) put options, particularly those with near-term expirations.

Take, for instance, the put option with a May 3 expiration at the $850 strike price, which was trading at $20.80 on the bid side. This strike price was 3.6% below the stock’s price at the time, representing a substantial 2.45% income opportunity from the premium alone. Notably, as Nvidia’s stock price closed at $887.89, these OTM puts did not convert into obligations, allowing investors to profit from both the option premiums and the stock’s appreciation.

Furthermore, the broader analyst community has set ambitious price targets for NVDA. Averages from multiple sources, including Barchart, Refinitiv (via Yahoo! Finance), and AnaChart, place Nvidia’s stock in a range from $955.78 to $1,008.90, underscoring a consensus on its upward trajectory.

For those looking to capitalize on these dynamics, the strategy of shorting OTM puts appears increasingly viable. A glimpse at the option chain for the May 31 expiration reveals that OTM puts are still fetching high premiums. For example, the $880 strike puts are trading at a premium of $40.90, which equates to a 4.67% yield. This is for a strike price over 4% below the current stock price, offering not just high yield but substantial downside protection.

The high implied volatility, now over 63.5%, suggests significant potential stock price movement, which does increase risk. However, the high premiums provide a buffer; for instance, shorting the $870 strike put offers a breakeven point of $833.20—nearly 10% below the current price.

Investors engaged in this strategy are not bound to hold until expiration. If Nvidia’s stock price remains stable, the diminishing option premium in the coming weeks could allow them to buy back the puts at a lower price, securing a profit and potentially reallocating their investment.

In conclusion, Nvidia’s stock, despite its recent gains, is bolstered by strong financial forecasts and a supportive market structure for strategic option plays. For current shareholders, shorting OTM puts could serve as both a source of additional income and a hedge against short-term declines, emphasizing Nvidia’s promising outlook in an innovative and evolving tech landscape.