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Nvidia (NVDA) stock is showing extremely high implied volatility in the lead up to their earnings announcement on November 20th.
There is also significant volatility skew with short-term options showing much higher implied volatility than long-term options.
One way to take advantage of this skew is via a diagonal put spread.
Let’s look at an example using Nvidia.
Nvidia Diagonal Put Spread Example
The trade I’m looking at is selling a November 22 put with a strike price of $133 and buying a December 6 put with a strike price of $128.
As of yesterday’s close, the November 22 put could be sold for around $2.15 and the December 6 put could be bought for $2.00.
The trade would result in a net credit of $15.
The risk on the trade is on the downside with a potential maximum loss of $485. This is calculated by taking the difference in the spread (5) multiplied by 100 and subtracting the premium received (15).
The maximum potential gain is around $370 which would occur if NVDA closes right at $133 on November 22.
The trade has a nice profit zone in between $127 and $157.
Aiming for a return of around 10-15% makes sense and I would set a similar stop loss.
The worst-case scenario is a sharp drop in NVDA stock early in the trade. For this reason, if the stock drops below $133 in the next few days, I would also consider closing the trade early to minimize losses.
The initial trade set up has a delta of 3 meaning the position is roughly equivalent to owning 3 shares of NVDA stock. Note that this delta number can change significantly as the stock starts to move.
Below is the payoff graph with the blue line representing the profit or loss at expiration and the purple line being the trade as of today.
Provided NVDA stock stays above $133 after their earnings announce, the trade should be ok.
Nvidia Company Details
The Barchart Technical Opinion rating is a 100% Buy with a Average short term outlook on maintaining the current direction.
Long term indicators fully support a continuation of the trend.
The market is approaching overbought territory. Be watchful of a trend reversal.
NVIDIA Corporation is the worldwide leader in visual computing technologies and the inventor of the graphic processing unit, or GPU.
Over the years, the company's focus has evolved from PC graphics to artificial intelligence (AI) based solutions that now support high performance computing (HPC), gaming and virtual reality (VR) platforms.
NVIDIA's GPU success can be attributed to its parallel processing capabilities supported by thousands of computing cores, which are necessary to run deep learning algorithms.
The company's GPU platforms are playing a major role in developing multi-billion-dollar end-markets like robotics and self-driving vehicles.
NVIDIA is a dominant name in the Data Center, professional visualization and gaming markets where Intel and Advanced Micro Devices are playing a catch-up role. The company's partnership with almost all major cloud service providers (CSPs) and server vendors is a key catalyst.
Of the 42 Analysts following NVDA there are 36 Strong Buy, 2 Moderate Buy and 4 Hold recommendations.
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.
On the date of publication, Gavin McMaster 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.
