Nvidia, a big winner in 2023, stays well placed, along with Microsoft, in running to compete with the AI thunder. And so we will look ahead to a long call butterfly trade for Nvidia stock.
This spread trade could yield a 5x return and more if the chart replicates only part of last year's performance.
With the December nonfarm payroll numbers released and profit-taking present in the markets, we are likely to see a bit of fading before the next leg up in the stock market.
We've also seen some sector rotation as the IBD outlook on the stock market suggested well ahead of the move. For this reason, we are likely to see some tech leaders move into more favorable prices. And then further upshot could arise as traders get lured in by better prices.
Patience is key here. And the stock on my radar continues to be the well-positioned Nvidia stock.
Nvidia Stock Today: The Set-Up
The long call butterfly spread is a neutral to bullish position and estimates that prices will rise over the longer term to deliver stellar results. This butterfly is unbalanced meaning that there is a wider distance between the short call spread than the long call spread within the butterfly position.
A butterfly spread is the combination of a long call spread and a short call spread where the short call spread is the same strike price for both spreads.
So, let's set up the trade in NVDA this way:
- Buy to open 1 NVDA call expiring June 21 with a 500 strike price
- Sell to open 2 NVDA June 21 550 calls
- Buy to open 1 NVDA June 21 610 call
The Breakeven Price
In this trade, total debit comes out to $4.20 per set of contracts. Thus, the break-even cost for Nvidia stock $504.20, or the price of the first long option strike plus the cost of the option.
The ideal event for this strategy? The stock moves at or just slightly over the price of the middle strike at around 10 to 15 days before the options expire. Optimally, this will yield close to the 5x gain I mentioned, all else being equal, and no volatility events affect the relationships in the option chains.
The ideal strategy result gives us four choices to exit the trade.
- One, sell the entire call butterfly spread once it carries an acceptable profit.
- Two, sell the entire call butterfly spread once it hits your loss threshold as determined by personal risk.
- Sell the entire butterfly at the moment that the price of the stock hits the middle price.
- Finally, sell the long call spread of the butterfly spread and leave the short call spread to expire worthless. This adds some measure of risk so it is best to see the stock under the 10-day simple moving average to have more confidence in the trade of leaving a short call in the market.
Stock hunting using fundamental and price strength within the IBD methodology is where I firmly plant myself under the backdrop of the current economic backdrop. I use technical analysis to find ideal buying opportunities in conjunction with the tools for strength seen on IBD.
Understanding The Long Call Butterfly
The goal of taking the butterfly trade is to gain exposure to profit, but to also significantly limit loss if we are incorrect.
The unbalanced call butterfly is used to offset cost of the position. If you want to have a balanced risk that involves nothing more than the cost of the debit, use 600 as the strike instead of 610. Doing so will increase the initial cost but also protect you from any additional downside.
Options sellers are positioned to win in two ways: Either Nvidia stock does nothing, or it moves within the ranges. We use this concept to minimize risk of market exposure.
For trade management, let's first identify key chart levels. The monthly resistance zone sits near $500, and support sits near $400. If we see some sharp dips, we will be in a position to potentially add to the position. Be patient in the current flow.
Nvidia Stock Scenarios
- Nvidia stock grinds lower from the top but does not break 400 for more than three days. This action shows itself as favorable to the traders looking for longer-term growth. We should look for bounces in the days following to confirm the strength of the chart.
- NVDA grinds higher much earlier in the cycle. The option position increases in value by more than 200%. In this case, we could certainly choose to sell the entire position and quickly take the gains, freeing up more capital to trade.
- Nvidia shares grind higher, test or breach the 550 price level, but immediately retreat. This suggests traders are not willing to pay more for the stock at the present time. We can cover the trade here. Why? The earlier the above situation happens in the cycle into the June expiration, the less we will make.
- Stock breaks down on volume for more than three days and breaks our personal risk thresholds. So we exit the trade.
Finally, we must consider closing this trade if the stock creeps past 575. This is not an option play that is good to hold into expiration.
As with all trades, consider what you like about holding the position in the first place and consider your risk carefully.
Be patient and allow price action to move around a range of your stops.
Anne-Marie Baiynd is a 20-year veteran trader of stocks, options and futures and is the author of "The Trading Book: A Complete Solution to Mastering Technical Systems and Trading Psychology." She holds no positions in the investments she writes about for IBD. You can find her on Twitter and Stocktwits at @AnneMarieTrades
