While semiconductor stalwart Nvidia (NVDA) has been a blisteringly strong performer, it also represents a source of confusion. Although NVDA stock is up roughly 169% year-to-date, it has struggled to breach the $135 level. Given this challenge, an options strategy called the bull put spread could offer an intriguing alternative. Considering these factors, I view NVDA as a hold.
Don't Miss our Black Friday Offers:
- Discover the latest stocks recommended by top Wall Street analysts, all in one place with Analyst Top Stocks
- Make smarter investments with weekly expert stock picks from the Smart Investor Newsletter
Why Should Investors Consider a Put Spread on NVDA Stock?
As I remain neutral on Nvidia (NVDA) stock, I’ve observed that those following the stock tend to fall into two distinct camps: the majority of investors are bullish, driven by Nvidia’s significant role in the artificial intelligence sector, while a smaller group of skeptics question the stock’s viability at its current valuation. The bullish crowd highlights Nvidia’s work in creating advanced graphics processors that drive machine intelligence, which has sent the company’s market value soaring.
On the other hand, a few bold investors have questioned the viability of NVDA stock. For example, TipRanks contributor James Fox noted that Nvidia trades at a scorchingly hot multiple to projected earnings. Further, while NVDA obviously demonstrated the ability to bounce back from corrective lows, it can’t quite seem to blow past $135 and convincingly set new milestones.
Given this situation, a bull put spread may be appropriate. The idea here is that traders are earning income from selling put options. At the same time, they also acquire a long position in a put at the same expiration date but a lower strike price. In this manner, the trader protects against the possibility of severe financial losses associated with selling the aforementioned put.
To clarify, that’s the mechanics behind the bull put spread. A simple explanation is as follows: rather than betting on a directional outcome (as is the case with simply buying a put or call), the put spread is a wager that the target stock will not fall below an established breakeven price.
Moreover, such a framework appears ideal for NVDA stock. It’s not entirely clear that Nvidia has what it takes to blow past technical resistance and hit $140, then $150. However, it seems evident that enough optimists exist that will support NVDA around the $120 level.
Ultimately, this suggests that counteracting forces could keep Nvidia in a sideways consolidation pattern. Such an outcome would not be helpful to pure bulls or bears. However, it’s a perfect setup for a bull put spread.
How Does a Put Spread Strategy Work in Practice?
To start, I want to emphasize that I’m neutral on NVDA stock, and this section will explore a strategy that aligns with that stance. There isn’t a one-size-fits-all approach when it comes to put spread strategies for NVDA, given the variety of options and opinions available. However, let’s dive into one short-term example to see how such a strategy could work in practice.
In this example, a trader considering a put spread would acquire two put options: one to generate income and the other to hedge against downside risk. For the August 30, 2024 expiration date, the trader might buy the $113 put with an ask of $1.51. At the same time, they would sell the $116 put with a bid of $2.
Since options usually cover 100 shares, selling the $116 put would bring in $200 in gross income, calculated as $2 multiplied by 100 shares. After purchasing the hedge for $151, the net income is $49.
The goal here is for both options to expire worthless. If that happens, the trader keeps the entire $49 premium. The breakeven price for this trade is $115.51, determined by subtracting the premium received per contract, which is 49 cents, from the sold put’s strike price of $116.
If NVDA stock drops significantly below this breakeven price, the maximum loss would be $251. This amount is derived from the difference between the strike prices of the put options, which is $3, minus the premium received per contract of 49 cents, and then multiplied by 100 shares, resulting in a maximum loss of $251.
Although this trade may seem unbalanced, risking $5.12 for every dollar of potential reward, it could be appealing for a trader confident that NVDA stock won’t dip below $116 by this Friday. In that case, it presents an opportunity to earn $49 for each bull put spread purchased.
Bull Put Spreads Offer a More Balanced Approach
To clarify, directional options, such as buying calls or puts, carry significant risk due to their reliance on precise market movements within a set timeframe; they may not align well, particularly with a neutral view like mine. In contrast, a bull put spread offers a more balanced approach, accommodating various market scenarios and minimizing risk. This strategy allows investors to benefit from a range of outcomes, making it a more prudent choice for those who, like me, see NVDA as holding steady rather than trending sharply in one direction.
Imagine buying a far out-the-money (OTM) call option in hopes it will become profitable. This is similar to attempting a challenging night landing on an aircraft carrier—highly speculative and fraught with uncertainty. Conversely, a bull put spread is akin to a more manageable landing where any safe arrival is a success.
In practical terms, a bull put spread ensures that the trader will earn a fixed amount of income, such as $49, if NVDA stock remains at $116 or rises. This strategy reduces the risk compared to more speculative bets and provides a cushion as long as NVDA doesn’t fall below $116 during the specified period, which seems like a reasonable scenario given current conditions.
Is Nvidia a Buy, Sell or Hold?
Turning to Wall Street, NVDA stock has a Strong Buy consensus rating based on 32 Buys, three Holds, and zero Sell ratings. The average NVDA price target is $149.89, implying a 15.86% upside potential from current levels.
Key Takeaway
While Nvidia benefits from strong bullish support at the lower bounds of the three-digit territory, it can’t quite seem to break convincingly above the $135 level. Therefore, it’s possible that NVDA stock may move sideways for a while. If so, that would be an ideal opportunity to deploy the bull put spread. So long as shares don’t drop below a defined level, traders can collect income, regardless of whether NVDA swings higher or continues along a sideways consolidation path.
