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Nvidia Inc (NVDA) stock seems to be treading water ahead of its quarterly earnings next month. One way to take advantage of this is to sell short out-of-the-money (OTM) put options for extra income.
NVDA is trading for $122.78 in midday trading on Tuesday, July 23. The stock closed at $122.57 on June 12, so it has traded flat for the past month.
In my last Barchart article on July 8, I said this made it ideal to short OTM puts: “Shorting Nvidia Out-of-the-Money Put Options Is Good Way to Make Extra Income.”
What To Do With the Friday, July 26 Put Options
For example, I suggested shorting the $125 strike price put option contract that expires this Friday, July 26. Any short-seller of these puts received a premium was $3.70, or a yield of 2.96% (i.e., $3.70/$125.00).
Even though NVDA is now below the strike price, the put option premium is still lower at $3.15 in the midprice. In other words, the short seller has a choice.
They can now close out the trade by entering an order to “Buy to Close” the contract (if it hasn't already been exercised). Or they can wait until Friday to see if the stock stays below $125. In that case, their secured cash will be used to buy 100 shares. But the breakeven price is much lower at $121.30. That makes it a good buy-in entry point.
In any case, it still makes sense to look at entering into a new short-put contract before this Friday's close. (Closing out the existing contract will help free up cash and margin to do this as well).
Shorting a New Out-of-the-Money (OTM) Put
For example, look at the August 16 expiration period, ending a little over 3 weeks from now (24 days). Note that this is close to the expected August 28 earnings release. As a result, there is a good chance the stock could rise before then if past trends hold up.
To be conservative let's look at a very out-of-the-money (OTM) strike price. For example, the $118.00 strike price put option has a $3.55 bid price. This is over 4.3% below today's price, providing good downside protection.
That $3.55 premium provides an immediate yield of 3.0% to the short seller. This can be seen by dividing $3.55 by $118.00, or 0.03.
In other words, if an investor secures $11,800 in cash and/or margin with their brokerage firm, they can enter a trade order to “Sell to Open” 1 put contract at this expiry period and strike price. The account will immediately receive $353.00, or 3% of the $11,800 invested.
Investors who do this trade also will have good downside protection. The breakeven price is $118-$3.55 per share, or $114.45, or 6.7% below today's spot price. That means that even if the stock falls to the strike price and the investor's cash is assigned to buy 100 shares, the net buy-in cost is only $11,445 for the 100 shares.
Note that investors willing to take on more assignment risk can sell short the $118.50 strike price and receive a $3.75 premium. That is an immediate yield of 3.16%, i.e., $375 on $11,850 invested per put contract shorted.
The bottom line is that this short-put play provides a good way for existing shareholders to make extra income. For example, if the investor can repeat this trade yielding 3.0% every 3 weeks for a quarter, the expected return is 12% (i.e., 3% x 4 trades during a quarter).
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
