Nvidia Corporation (NASDAQ:NVDA) is a great secular story. In the near-term though, buying NVDA stock could test the mettle of investors as signs of a top build. But with no guarantees from price charts, one way to work around this seemingly difficult dilemma is through the use of a modified fence strategy. Let me explain.
As last year’s best-performing stock in the S&P 500, and on pace for a possible repeat performance in 2017, NVDA stock has been on an enviable tear. And as most active investors also know, Nvidia’s rise to prominence has not been without good reason either.
Bottom line, Nvidia has been growing hand over fist, crushing Wall Street views and is very well-positioned in more than a few hot markets ranging from artificial intelligence and deep learning, gaming, autonomous autos and even cryptocurrency mining.
I’m confident you’ve heard this all before. It’s also likely the bullish Nvidia narrative came across your radar at much lower prices in NVDA stock given the meteoric rally. And guess what? Shares of Nvidia could continue even higher without you, but then again …
NVDA Stock Daily Chart
Click to Enlarge
Technically, my concern is focused on NVDA’s price action following its last two earnings reports. On the heels of May’s blowout report shares rallied strongly for nearly four weeks, but culminated in a bearish shooting star candlestick on the weekly chart. While NVDA stock ultimately rallied to new highs, those gains have not come easily.
NVDA has failed momentum traders and, more recently, those buying into the aftermath of the early August earnings topper. This quarter, the weekly price action quickly formed an engulfing bearish candlestick after scoring an ever-brief, marginal higher high pattern amidst a bearishly divergent stochastics condition.
Looking forward, the case for a healthier correction, perhaps as much as 30% is building, but that’s not something to necessarily fear. It’s our contention investors bullish on Nvidia’s long-term prospects simply need to be a bit smarter and pragmatic about how and when to enter NVDA stock.
NVDA Stock Bullish Spread Combo
Click to Enlarge
The combination consists of an out of the money call spread financed by the sale of an out of the money put spread. I like to think of the modified fence as having one’s cake and eating it too.
This spread allows the trader to buy shares at a discount, maintain limited risk and have long directional exposure should NVDA surprise us technically and reaffirm its uptrend near-term.
With NVDA stock at $161.49, selling the Oct $135/$125 put spread and buying the Oct $185/$190 call vertical is priced for a small credit of 15 cents and favored by this strategist.
What’s this spread package offer the NVDA stock trader?
First, at expiration if NVDA remains between $135 and $185 the combination will expire worthless and the trader will capture the credit. In the event of a rally that could amount to being small potatoes versus the profits from holding long stock and a potential limitation which needs to be understood before positioning with this strategy.
The good news is if shares rally prior to maturity in October, the position could accrue larger paper profits before the call spread goes in the money due to the combination’s long directional delta bias. Of course, as with any bull call spread, the real money and max return is above the higher strike. In this case, the NVDA stock trader would capture $5.15 above $190 at expiration.
Looking in the other direction, the small-potato profit provided by the credit certainly looks nice by comparison to owning stock if Nvidia shares drop in price over the life of the combination but remain above the sold put spread.
If there is a larger corrective move, the modified fence maintains a breakeven of $134.85. That’s a margin of safety of nearly 16.50% from today’s share price, but it could get even better than that. Risk with this combination is limited to $9.85 below $125 or the equivalent of 6% of NVDA stock risk.
Thus, there’s always the potential opportunity to buy shares at a much deeper discount with total risk control should a more calamitous-looking, but possibly opportunistic correction develop in Nvidia.
Investment accounts under Christopher Tyler’s management do not currently own positions in any securities mentioned in this article. The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. . For additional market insights and related musings, follow Chris on Twitter @Options_CAT and StockTwits and feel free to click here to learn more about how to design better positions using options!
