Multi-leg options strategies can be powerful tools for risk management. Unlike pure-play speculation, methodologies such as the bear call spread — which is a neutral to moderately bearish trade — involve extracting limited rewards in exchange for limited risk. It can be a particularly powerful weapon when you’re not entirely sure that a directional wager makes much sense.
Case in point is semiconductor firm Nvidia ($NVDA). It’s difficult to ignore the virtues of the technology giant. Thanks to its advanced graphics processors, the company effectively undergirds the latest innovations in artificial intelligence. With Grand View Research stating that the global AI sector could reach a valuation of over $1.81 trillion by 2030 — a CAGR of 36.6% — NVDA stock is well positioned for impressive growth.
Certainly, the tech enterprise continues to impress Wall Street with robust earnings reports and strong sales projections. Notably, Wall Street analysts project that Nvidia will post earnings per share of $2.84 by the end of this fiscal year. That’s up 138.66% from last year’s print of $1.19. As well, the company may generate revenue of $125.49 billion, up 125.3% from last year.
Still, NVDA stock isn’t without criticism. In its most recent financial disclosure for the second quarter, Nvidia posted EPS of 68 cents. This beat the target of 64 cents. However, with an earnings surprise of “only” 6.3%, it was lower than Q1’s surprise of 9.8%. And in Q4 of the prior fiscal year, Nvidia enjoyed a surprise of 11.9%.
Technical Woes Warrant a Bear Call Spread on NVDA Stock
The concerns don’t just end with the fundamentals. Indeed, the technicals aren’t up to snuff either. Most conspicuously, NVDA stock has consistently failed to break above the $130 level, which is acting as strong resistance. More recently, it’s struggling to stay above the $120 line.
Now, at some point, the smart money is on NVDA stock breaking out of its brain fog. With so many enterprises investing in machine intelligence, it appears unlikely that Nvidia will stay rangebound forever. For most investors, the immediate uncertainty means waiting on the sidelines for circumstances to decisively improve. However, astute traders can deploy a bear call spread.
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A call spread falls under the category of options trading strategies known as vertical spreads. It’s called that because these spreads involve multiple options with the same expiration date but at different strike prices. In other words, one strike price is (vertically) positioned above the other.
Ultimately, the goal of the bear call spread is to generate income from a sold call. However, merely selling calls is risky if one doesn’t own the underlying security to cover the transaction in case the other side of the trade — the buyer of the call — decides to exercise the option. To limit this liability, the call seller also buys a call option at a higher price.
The net income received from the trade (premium received from the sold call minus the premium paid of the bought call) is the maximum profit available. On the other hand, the figure represented by the difference in the strike prices minus the net premium received is the maximum loss should the trade go awry.
A Vertical Spread for the Aggressive Trader
To be sure, investors have myriad pathways to take regarding a bear call spread, depending on their risk-reward profile. However, if you happen to be aggressive, the below trade might be attractive:
Expiration date: Sept. 13 (this Friday)
Sell: $110 Call at a bid of $1.32
Buy: $116 Call at an ask of 18 cents
Breakeven at $111.14 (NVDA stock cannot move above this point lest losses materialize)
Max profit: $1.14 per contract
Max loss: $4.86
Risk/reward: 4.26 to 1 (for every $1 of income received, the trader puts $4.26 at risk)
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Technically speaking, this trade might work because as of this moment, it appears that NVDA stock has trouble breaking above $108. If the bears can harass the bulls for next 72 hours, the pessimists can scalp a quick profit.
Of course, the risk is that NVDA stock is a mover — when it goes, it goes. That said, it’s interesting that the options chain for the derivatives expiring this Friday features an implied volatility of 55.41%, much lower than the historical volatility of 76.49%.
Essentially, the market is anticipating less mobility for NVDA stock, either to the downside or up. If so, resistance at $108 could hold — and that may mean a quick profit to get your weekend off on the right note.
Disclaimer:
Stock trading involves significant risks and is not suitable for every investor. The strategies and ideas discussed in this article are for informational and educational purposes only and should not be construed as financial or investment advice. Always conduct your own research or consult with a licensed financial advisor before making any investment decisions.
Please note that selling options can expose you to unlimited liability if the underlying asset moves against you. It is crucial to exercise your in-the-money bought options to offset the potential liability of your in-the-money sold options, particularly in volatile markets. Make sure you fully understand the risks and mechanics of options trading before engaging in these types of transactions.
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