He underestimated Cloud, yes.
Sephiroth is aware that he's pretty much the best thing that ever was, and he can get overconfident.
Also, the Sephiroth at the end of FFVII isn't the real Sephiroth. It's the Sephiroth in Cloud's mind. Sephiroth died when you beat Safer Sephiroth. It basically symbolizes Cloud getting freedom from his control. It's an "out-of-body experience," as evidenced by the fact that Cloud's...spirit, or whatever, flies out of him before the fight.
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