Nvidia Corporation (NASDAQ:NVDA) is a momentum stock that has become the 2017 poster child for the semiconductor sector. Momentum stocks like NVDA stock move fast so it’s no surprise that the company has had a few sharp corrections this year.
Most recently is one that started late November, and therein lies my opportunity. I want to set a bullish trade to profit from what others fear in Nvidia.
Management has consistently over-delivered with impressive performance on all metrics and I expect that to continue. Therefore, I see no intrinsic threat, but I do have to rely on the markets in general to hold. If equities correct, NVDA stock will fall fast and I have to be ready to own the shares if my worst case scenario materializes.
Fundamentally, Nvidia stock is relatively expensive. Its price-to-earnings ratio is three times that of Intel Corporation (NASDAQ:INTC) and 1.5 times the P/E of Microsoft Corporation (NASDAQ:MSFT). So it is evident that investors expect more from it than the older technology companies. So far they’ve been rewarded accordingly.
Technically, NVDA stock performance has been awe inspiring. It’s still up more than 70% year-to-date, which is double the performance of the Technology Select Sector SPDR Fund (NYSEARCA:XLK), MSFT and INTC.
But there are risks.
How to Trade NVDA Stock
The $170/$180 zone has been pivotal this year. It was resistance, but in September, the bulls prevailed and they have used it as support ever since. However, here they are approaching that new support zone again and if it fails, the bears could push NVDA stock down to $160-per-share or lower. Although this is not a forecast, it is a scenario that I have to consider.
Expectations are important to the price action. Even though Nvidia stock has already fallen 13% since the highs, it is still trading close to the average price target. This is testament to how fast this winner has risen in 2017.
But “hopium” is a double-edged knife, analysts currently expect so much of it, so if they don’t get what they expect, they will punish Nvidia stock.
Nevertheless, I still believe that dips are normal and I will use this one to generate income with no money out of pocket. As long as the macroeconomic thesis remains this strong, NVDA stock will find footing. This is a rinse-and-repeat trade for me, so I come into this with profits in pocket.
Momentum stocks are scary to catch on the way down, especially when stock markets are at all-time highs. NVDA is a proven winner — I can bet on it.
The Trade: Sell the NVDA Jan $165 put for $1.30 per contract. This is a bullish trade, which gives me an 85% theoretical chance to retain maximum gains. But if the price falls below my strike, then I accrue losses below $163.70.
Selling naked puts carries big risk, especially in a three-digit momentum stock. For those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the NVDA Jan $165/$160 bull put spread, which has about the same odds of winning but with much less risk. Yet, the spread will deliver 10% in yield. Compare this to risking $187 to buy the shares outright and without any room for error, expecting a rally to profit.
Ultimately, investing in stocks is fraught with danger, so I never risk more than I am willing to lose.
Get my newsletter for free here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.
