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Three weeks ago, we recommended Nvidia Inc. (NVDA) stock in a June 22 Barchart article and shorting out-of-the-money puts. Now, NVDA is near its target prices, and the short play is successful. What is the best play here?
NVDA is at $171.30, up over 4.5% today. Trump OK'd an export license to sell its powerful H20 AI chips to China after Nvidia's CEO, Jensen Huang, met with President Trump. The Wall Street Journal said this has been a top seller for Nvidia in China and was specially designed for the Chinese market.
My prior price target was $178 per share using an estimated 55% forward free cash flow (FCF) margin (i.e., FCF/sales), as well as a 2.85% FCF yield valuation metric (i.e., 35x FCF multiple).
Last quarter, Nvidia made a 59% FCF margin. So, if this continues over the coming year, NVDA stock could have further to go.
Moreover, analysts have lifted their price targets. Let's look at this.
Updated FCF Estimates
In Q1 ending April 27, Nvidia generated $26.1 billion in FCF on $44.06 billion in sales. That represents a 59.2% FCF margin. Over the trailing months, according to Stock Analysis, it's generated $72.06 billion FCF on $148.5 billion in sales, or a 48.5% FCF margin.
So, it seems reasonable to assume Nvidia could make at least a 57% FCF margin going forward. Here's how that would work out.
Analysts expect sales to rise to a range between $199.89 billion this year ending Jan. 2026 and $251.2 billion next year. That puts it on a next 12 months (NTM) run rate of $225.5 billion. Moreover, now that it will be able to sell to China again, let's assume this pushes sales at least 5% higher to $236.8 billion:
$236.8b NTM sales x 57% FCF margin = $135 billion FCF
Just to be conservative, let's use a 55% margin on the lower NTM sales estimates:
$225.5 billion x 55% margin = $124 billion FCF
So, our estimate is that FCF over the next 12 months could range between $124 billion and $135 billion, or about $130 billion on average
Updating Price Targets
Therefore, using a 30x FCF multiple (i.e., the same as dividing by 3.33% FCF yield):
$230b x 30 = $6,900 billion market cap (i.e., $6.9 trillion)
That is 65% over today's market cap of $4.178 trillion, according to Yahoo! Finance (i.e., at $171.35 p/sh).
In other words, NVDA stock could be worth 65% more, or $291.55 per share.
$171.35 x 1.65 = $282.73 price target
That is what might happen over the next 12 months (NTM) if analysts' revenue targets are hit and its FCF margin averages 56%.
Analysts have closer price targets. The average of 66 analysts surveyed by Yahoo! Finance is $173.92. However, that is higher than three weeks ago, when I reported that the average was $172.60.
Moreover, AnaChart.com, which tracks recent analyst recommendations, now reports that 39 analysts have a $200.71 price target, up from $179.87 three weeks ago.
One way to play this is to sell short out-of-the-money puts. That way, an investor can set a lower buy-in price and still get paid extra income.
Shorting OTM NVDA Puts Here
In my last Barchart article on June 22 ("Make Over a 2.4% One-Month Yield Shorting Nvidia Out-of-the-Money Puts"), I suggested shorting the $137 strike price put option expiring July 25. The yield was 2.48% over the next 34 days (i.e., $3.40/$137.00).
Today, that contract is almost worthless, as it's trading for just 8 cents. In other words, the short seller of these puts has made almost all the money (i.e., the stock has risen, making the short-put play successful). The investor's account has little chance of getting assigned to buy 100 shares per put contract at $137.00 on or before July 25.
It makes sense to roll this over by doing a “Buy to Close" and entering a new trade to “Sell to Open” at a later expiry period and higher strike price.
For example, the Aug. 29 expiry period, 45 days to expiry or DTE (which is after the expected Aug. 27 Q2 earnings release date), shows that $155.00 strike price put has a midpoint premium of $3.93. So, the short-put yield is:
$393/$155.00 = 0.2535 = 2.535% over 45 days
That works out to an annualized expected return (ER) of +20.28% (i.e., 2.535% x 8). So, even if NVDA stock stays flat, the investor stands to make good money here shorting these puts every 45 days (assuming the same yield occurs).
Downside Risks and Hedges
There seems to be a low risk here, given that the delta ratio is just 23%. But, given how volatile NVDA has been, and that the stock is at a peak, it might make sense to use some of the income received to buy puts at lower strike prices.
Keep in mind that the breakeven point, i.e., the price where an unrealized loss could occur, is $151.07:
$155-$3.93 = $151.07
That is 11.8% below today's price. But it is not uncommon for a stock like NVDA to fall 20% from its peak. That would put it at $137.00.
So, using some of the income to buy long puts at $140 or $145 is not unreasonable. That would cost between $144 and $204 ($174 on average) for the $15,500 investment (net of $393 already received):
$393 income - $174 long hedge = $219, or
$219 / $15,500 invested in short put play = 1.41%
New Breakeven = $15,500 = $174 = $15,326 or $153.26 per put contract
This means that the investor's potential (unrealized) loss is between $14,250 and $15,326, or -$1,076 net on the $15,326 net investment, or -7%.
But keep in mind that this is only an unrealized loss. The investor would have protected himself from a much lower downside by buying long puts from the income received.
And, after all, the price target is substantially higher, so the investor might be willing to hold on or even sell out-of-the-money call options to recoup some of the unrealized loss.
The bottom line here is that NVDA has room to move higher. Shorting OTM puts with a lower strike price long put hedge is one good way to play this.
