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Nvidia Inc (NVDA) produced strong free cash flow Q2 results on Aug. 28, albeit lower than last quarter. Its FCF margin was stayed high at 45%. This implies NVDA stock is still worth over 55% more at $184 per share. Shorting out-of-the-money (OTM) put options is a way to play this that makes sense.
NVDA stock is at $118.18 in morning trading on Friday, Aug. 30. The stock has dropped since a peak of $130 on Aug. 19, but it's been relatively flat for the last three months.
This makes it ideal for selling short OTM puts. More on this below. I discussed this in my recent Aug. 13 Barchart article, “Nvidia Put Options Are Attractive to Short Sellers Given the High Put Premiums.” I suggested shorting the $105 strike price put expiring today. That yielded 3.33% and it will likely expire worthless - ideal for the short seller.
First, let's look at why NVDA stock could still be undervalued here.
Strong Free Cash Flow Results
Nvidia reported that its fiscal Q2 2025 (ending July 28) revenue rose +15% Q/Q to $30.04 billion from $26.04 billion in Q1 and +122% Y/Y. However, free cash flow (FCF) fell from $14.936 billion in Q1 to $13.483 billion, a drop of 9.73%. This can be seen on page 7 of the CFO Commentary release.
That could explain why NVDA stock has shown some weakness since releasing its results. However, this still means that the company produced a very high FCF margin (i.e., FCF as a percent of sales).
For example, the Q2 FCF represents almost 45% of revenue (i.e., $13.48b FCF / $30.04 b revenue = 0.4488). That means that a little less than half (45%) of sales revenue goes straight into the company's bank account with no cash obligations.
This cash flow is after all cash expenses, capex spending obligations, and even its net working capital requirements. It's also “free” to be spent on dividends, buybacks, acquisitions, debt reduction, or accumulate on the balance sheet.
Granted, this was lower than the fantastic 57.4% FCF margin Nvidia made last quarter (i.e., $14.9b FCF / $26.04 billion revenue). But that high FCF margin was not likely to last.
Nevertheless, we can assume that Nvidia could generate at least 45% FCF margins going forward. That is useful in setting a price target for NVDA stock.
Price Target for NVDA Stock
For example, analysts now project that next year the company will produce $174.34 billion in revenue for the year ending Jan. 2026. This is up significantly from three months ago when the forecasts were for $157.38 billion (i.e., +10.8%), as I wrote in my June 17 Barchart article after its Q1 results.
Therefore, applying a 45% FCF margin against this $174.34 billion results in a free cash flow forecast of $78.45 billion next year. That is significantly higher than the $46.786 billion in FCF over the last 12 months (LTM), based on Seeking Alpha data (i.e., +67.7%).
This implies that NVDA stock could be worth significantly more than today. For example, assuming the market applies a 1.75% FCF yield to this $78.45 billion in FCF, its market cap could rise to $4,483 billion (i.e., $78.45b/0.0175 = $4,482.86b). (Note that this is a lower metric than the 1.50% FCF yield I used in the past).
In other words, NVDA's market cap could rise +55.6% over its existing $2,881 billion market cap today. That assumes the company generates 45% FCF margins over the next year and the market values this with a 57x multiple (i.e., the inverse of 1.75% yield).
This sets the price target at $183.88 per share (i.e., $118.18 x 1.556) over the next year.
Analysts Agree NVDA is Undervalued
Analysts all seem to have higher price targets for NVDA stock as well. For example, Yahoo! Finance reports that the average of 49 analysts is $142.75 per share (+23.5%). Similarly, Barchart's survey of analysts shows a mean target of $142.60.
In addition, AnaChart, a sell-side analyst tracking site, shows that 39 analysts have an average $143.43 price target. However, AnaChart shows that some of the best analysts with good track records predicting NVDA stock have much higher price targets.
For example, the table below from AnaChart shows that Hans Mosesmann of Rosenblatt has a $200 price target. He has been right almost 90% of the time (Price Targets Met Ratio). In addition, Mark Lipacis of Evercore recently raised his target price to $150 from $145. He has been right 95.9% of the time he set a price target on NVDA stock.
This shows that analysts all seem to be very bullish on NVDA stock, especially given its latest results.
Shorting OTM Puts in NVDA
One way to play this, as mentioned earlier, is to sell short out-of-the-money (OTM) put options in nearby expiry periods. For example, look at the Sept. 20 expiry period, which is 3 weeks away.
It shows that the $113 strike price, 4.20% below today's price, has a premium of $3.10 on the bid side. That represents a short put yield of 2.74% over the next 3 weeks (i.e., $3.10/$113.00).
In other words, an investor who secures $11,300 with their brokerage firm can enter an order to “Sell to Open” 1 put contract and immediately receive $310 in their account. Over the next 3 weeks, as long as NVDA stock stays over $113, the investor will have no obligation to have the $11,300 buy 100 shares at $113.00. In the meantime, they keep the $310.
So, over one quarter, if this trade can be repeated the investor could make an expected return (ER) of $1,240 (i.e., $310 x 4). In other words, the ER return yield is 10.97% over the next 12 weeks.
This is why it makes sense for investors who already own NVDA stock to sell short OTM puts. They gain extra income while waiting for the stock to rise to its price target.
The bottom line is that Nvidia's strong free cash flow could lead to much higher prices for NVDA over the next year. One way to play this is to short OTM puts in nearby expiry periods.
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.
