The good news is that there is a way to get paid to wait for a stock to fall to your desired price. By selling a put option you are obligating yourself to buy 100 shares of the underlying stock at the strike price if the option is exercised before the expiration date. Otherwise the option expires worthless. You receive a premium for this obligation, allowing you to generate income as you wait for the stock price to fall.
Still cheap, but not as cheap
NVIDIA Corporation (NASDAQ:NVDA), the leader in graphics processors, saw its stock fall from around $25 per share in early 2011 to around $11 per share towards the end of 2012. Pessimism about the PC market, which NVIDIA Corporation (NASDAQ:NVDA) relies on for sales of its GPUs and most of its revenue, is likely responsible for the depressed price. But in the latest quarter NVIDIA Corporation (NASDAQ:NVDA) reported better-than-expected earnings, with growth in the GPU division even as PC sales sank. This sent the stock up to about $14.50 per share.
NVIDIA Corporation (NASDAQ:NVDA) has about $6 in net cash on its balance sheet, and in fiscal 2012 earned roughly $1 per share in free cash flow. That puts the adjusted P/FCF ratio at about 8 now, and as low as 5 at the end of last year. So the stock went from being ultra-cheap to extremely cheap.
But there’s still some reasons to be pessimistic, at least in the short term. Nvidia expects flat sales in its Tegra division after delaying the launch of the Tegra 4 to focus on the Tegra 4i, a chip which includes an integrated LTE modem. This could cause weak earnings in the short term until the Tegra line proves itself to be a real competitor.
So if $14.50 isn’t cheap enough for you, you can sell a put option at a lower strike price. The August put option with a $13 strike price could be sold for $0.28 share. This would net you $28 for each contract you sell in return for the obligation to buy 100 shares of NVIDIA Corporation (NASDAQ:NVDA) at $13 per share if the option is exercised. Here are the two possible scenarios:
| Scenario | Outcome |
|---|---|
| The stock price is above $13 per share at expiration | The option expires worthless and you are not required to buy any shares. The $28 per contract which you received gives you a total return of 2.15% over about 80 days, or 9.7% annualized. You can now sell another set of put options. |
| The stock price falls below $13 per share | You buy 100 shares of NVDA for each contract which you sold. The premium reduces your cost basis to $12.72 per share. You now own the stock that you wanted at a price which you’re happy with. |
An increasingly diversified tech giant
Microsoft Corporation (NASDAQ:MSFT) is well know for its Windows operating system and Office software. But the company also has a fast growing server and tools division, almost equal in size to the Windows division. Its new cloud-based version of Office, Office 365, has proven popular, and Microsoft Azure is a real competitor to Amazon.com, Inc. (NASDAQ:AMZN)’s web services.
Microsoft Corporation (NASDAQ:MSFT) stock could have been bought for around $26 per share towards the end of last year. After reporting better than expected earnings the stock took off, briefly hitting $35 per share before falling back around $34 per share.
Microsoft Corporation (NASDAQ:MSFT) currently has about $60 billion in net cash, or $7.15 per share, and should generate about $27 billion in free cash flow this year. That works out to $3.20 of free cash flow per share, putting the adjusted P/FCF ratio at about 8.5. Last year this ratio was as low as 5.9. So Microsoft Corporation (NASDAQ:MSFT) is in a very similar boat in terms of valuation as NVIDIA Corporation (NASDAQ:NVDA).
Of course, there’s still pessimism around the lackluster response to Windows 8, so perhaps you’d like to pay a lower price for Microsoft Corporation (NASDAQ:MSFT). You could sell the August put option with a $32 strike price for a premium of $0.61 per share. This would net you $61 per contract sold. Here are the two possible scenarios:
| Scenario | Outcome |
|---|---|
| The stock price is above $32 per share at expiration | The option expires worthless and you are not required to buy any shares. The $61 per contract which you received gives you a total return of 1.91% over about 80 days, or 8.6% annualized. You can now sell another set of put options. |
| The stock price falls below $32 per share | You buy 100 shares of MSFT for each contract which you sold. The premium reduces your cost basis to $31.39 per share. You now own the stock that you wanted at a price which you’re happy with. |
