Nvidia is due to report earnings on Wednesday after the closing bell. The options market is pricing in an 11.3% move in either direction. The last six earnings reports saw Nvidia stock stay above its lower expected range. Here's a bull put spread option trade if you believe Nvidia can do it again.
Setting Up The Option Trade On Nvidia Stock
First, we'll start with the expected range from earnings. We'll take the at-the-money put and call for the nearest expiration after earnings, due on Feb. 23. This morning the two premiums added together traded around 77, or 11.3% of the stock price. This gives you a range in which Nvidia stock is likely to trade. Of course there are no guarantees and it doesn't tell you direction.
Now that we know the expected range, let's find a bull put spread that has the short strike roughly 11% below the stock price.
Remember with a bull put spread, we start by selling a put and collecting the premium. That part is bullish. But to reduce the risk, we buy a put at a lower strike price in case the trade doesn't go in our expected direction.
For Nvidia stock, we can sell the 605 put expiring on Feb. 23 for roughly 8.75 per share. That's about 11.3% below the price as of this morning. Then we'll buy the 600 put with the same expiration for roughly 7.65. That creates the bull put spread.
The difference of 1.10 is the net premium you collect per contract. Multiplying by 100 shares gives you a $110 credit for a block of share. This is also the maximum profit if Nvidia finishes above 605 at expiration.
For the maximum loss, you take the premium received and subtract it from the five-point difference in the strikes. Again multiplying by 100 shares, gives you a maximum loss of $390. You will lose the full $390 if Nvidia stock closes below 600 at expiration. A comforting feature of the bull put spread is that you always know your worst-case scenario ahead of time so you can manage risk better.
Taking the max profit divided by the max loss gives you a 28% return on risk in just a few days' time.
The break-even point for the bull put spread is 603.90 which is calculated as the short strike at 605 less the 1.10 option premium per contract.
Managing The Trade
There is little room for adjustment with short-term trades such as this, held over earnings. They either work or they don't.
Nvidia stock has been a standout leader of this rally. According to the IBD Stock Checkup, it's ranked No. 1 in its industry group. It has a Composite Rating of 99, an EPS Rating of 99 and a Relative Strength Rating of 98. It doesn't get much better than that. But, it got extended along with the market and that is important to consider. But Nvidia stock doesn't have to go up for this trade to win, it just has to stay above that lower expected range.
While a 28% return in a few days would be nice, the possibility of losing 100% is also very real. As such, this style of trade is only for traders with a high-risk tolerance.
If NVDA stocks ends below 605, long-term investors could consider taking ownership of the 100 shares and selling covered calls against it.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setup is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
