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Nvidia Inc (NVDA) stock has recovered from its recent lows but its put option premiums remain elevated. As a result, selling short deep out-of-the-money puts is an attractive income play for short sellers.
NVDA stock is at $114.53 in midday trading on Tuesday, Aug.13. This is up over 17% from a recent closing low of $97.52 on Aug. 8. However, NVDA stock is still well off its recent peaks of $134.91 on July 10 and $135.58 on June 18.
Analysts are now forecasting earnings per share (EPS) of 64 cents for its quarterly results due out on Aug. 28. That would be higher than its prior 61 cents EPS last quarter. Revenue is expected to be $28.54 billion, also higher than last quarter's $26.04 billion sales.
Nevertheless, the stock's put options prices remain very high. This presents a unique opportunity for short sellers of deep out-of-the-money (OTM) strike price put options in near-term expiry periods.
Shorting OTM Puts for Income
For example, the Aug. 30 expiration period, 17 days from now, shows that the $105 strike price has attractively priced put options for short sellers. This strike price is over 8.5% below today's price of $114.53, yet the bid side premium is high at $3.50 per put contract.
That means any short seller of these puts would have a breakeven purchase price of $105-$3.50, or just $101.50 per share, 11.37% below today's price.
Nevertheless, the short seller receives an immediate yield of 3.33% (i.e., $3.50/$105.00).
That means that if the short seller secures $10,500 with their brokerage firm they can enter an order to “Sell to Open” 1 put contract at $105 for expiry on Aug. 30. The account will immediately receive $350.00. So, the net yield is $350/$10,500, or 3.33%.
As long as NVDA stays over $105 before the close on Aug. 30, the investor will not have to purchase shares. That is why this works best for long owners of NVDA stock. They get to receive any potential upside in the stock. Moreover, the extra income also helps with any deterioration in the price in the short term.Moreover, more risk-averse investors can sell short higher striker price puts for more income. For example, the $107 strike price has a $4.15 bid-side premium. That provides an immediate yield of 3.879% (i.e., $4.15/$107).
This strike price is still 6.8% below today's price, providing good downside protection to the short-seller. Moreover, the breakeven price is $107-$4.15, or $102.85. That is 10% below today's price.
In addition, it's not that much higher than the $101.50 breakeven price of the $105 strike price play. So, given the slightly higher yield it might make more sense to short these puts. After all, there is only a little more than 2 weeks until these puts expire.
The bottom line is that these puts have elevated prices and provide good yields to short sellers. It will probably work well for existing shareholders, especially if NVDA keeps rising ahead of its upcoming earnings on Aug. 28.
One reason is that analysts expect NVDA stock to rise.
Analysts Have Higher Price Targets
For example, Yahoo! Finance says that its survey of 49 sell-side analysts has an average price of $125.63. That is 10% higher than today's price.
Moreover, AnaChart.com, a site that tracks sell-side analysts' stock price targets, says that 39 analysts who've recently written on NVDA stock, have an average $135.23 price target. That represents a potential upside of over 18.6% from today.
In addition, AnaChart shows that some of the best-performing analysts have higher price targets. For example, the table below shows that each of the top five analysts have had Price Targets Met Ratio metrics of 80% to 100%. That means that their price targets have been met 80% to 100% of the time.
It shows, for example, that Quinn Bolton of Needham has a $120 price target and he has been right 100% of the time he has written on NVDA. Similarly, Richard Shannon of Craig Hallum, who has a $125 price target, has been right 90% of the time he has written on the stock and provided a price target.
That should give investors a good deal of confidence that NVDA stock is likely undervalued here. That means that shorting deep out-of-the-money (OTM) put options is likely to do well and be profitable.
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.
