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. |
Mini Options!
For a long time stocks that had a high price per share, like Apple Inc. (NASDAQ:AAPL) were out of reach for those looking to sell options on the stock. Having enough cash to buy 100 shares of Apple Inc. (NASDAQ:AAPL) is no small feat, leaving the average investor out in the cold. To fix this problem, “mini” options were recently introduced for select stocks. A mini option is identical to a normal option except that it is based on 10 shares instead of 100. This allows a small-time investor to sell options on Apple as long as they can buy at least 10 shares.
Apple’s epic fall from grace has already been discussed to death. The stock fell from around $700 to about $445 today after reaching a low of $385. Determining the value of Apple Inc. (NASDAQ:AAPL) is difficult, but there are a few things that can be said. Apple Inc. (NASDAQ:AAPL) has about $152 in net cash per share, and its 2012 free cash flow was roughly $44 per share. This puts the adjusted P/FCF ratio at 6.66.
Now, the pessimism regarding Apple Inc. (NASDAQ:AAPL) is based on uncertainty about future growth. Cheaper Android-based devices are flooding the market, causing Apple’s margins to shrink. Android is quickly becoming the dominant mobile operating system, and new competition from Microsoft’s Windows phone and Research In Motion Ltd (NASDAQ:BBRY) will only make things harder.
Based on current earnings Apple Inc. (NASDAQ:AAPL) is dirt cheap. But since the future is fuzzy in terms of profitability, maybe you want a bit of a lower price. The August $410 mini put option can be sold for $10.45 per share. This would net you $104.50 per contract sold, ten times less than a normal option. Here are the two possible scenarios:
| Scenario | Outcome |
|---|---|
| The stock price is above $410 per share at expiration | The option expires worthless and you are not required to buy any shares. The $104.50 per contract which you received gives you a total return of 2.55% over about 80 days, or 11.5% annualized. You can now sell another set of put options. |
| The stock price falls below $410 per share | You buy 10 shares of AAPL for each contract which you sold. The premium reduces your cost basis to $399.55 per share. You now own the stock which you wanted at a price which you’re happy with. |
The bottom line
Put options can allow you to generate income while you wait for a stock price to fall. This works well if a stock is trading slightly above what you’d like to pay for it, allowing you to set an entry price and get paid to wait.
Note: The premiums used above are accurate as of this writing.
The article Buy These Tech Stocks at Lower Prices originally appeared on Fool.com and is written by Timothy Green.
Timothy Green owns shares of Microsoft and NVIDIA. The Motley Fool recommends Apple and NVIDIA. The Motley Fool owns shares of Apple and Microsoft. Timothy is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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