Tee Up a Trade Ahead of Nvidia Earnings

All eyes are on Nvidia (NASDAQ:NVDA) stock this week as the semiconductor giant steps up to the earnings plate. But it’s not just the anticipation of another round of numbers that has the Street all abuzz; it’s also the freshly released news that a 4 for 1 stock split is on the horizon.

Nvidia (NVDA) logo on a microchip
Source: Antonio Baccardi / Shutterstock.com

In today’s article, we’re going to break down the implications of the split for NVDA stock and preview market expectations heading into Wednesday night’s report.

Stock splits carry many advantages. Some dismiss them as mere financial shenanigans, but it’s more than magic with math. There are real-world benefits that usually accompany them. We’ll list a few, but first, let’s make sure you understand the dynamics surrounding Nvidia’s upcoming adjustment.

NVDA Stock Split Benefits

Historically the most common type of split is 2 for 1. But, with Nvidia’s stock price rising so much over the past five years, the company decided to go bigger on the split to pull prices even lower. Remember, NVDA stock was trading at $20 in 2015 before the semiconductor industry exploded.

Suppose you own 25 shares at $600 pre-split. When the adjustment happens, your position will balloon to 100 shares while the share price gets cut to $150. As always, there’s no net change in the value of your investment.

But that doesn’t mean there aren’t some psychological and trading perks that come with the price reduction.

The cheaper price brings in a new class of potential buyers that were previously turned off by the sky-high price for starters. It also increases the daily trading volume bringing greater liquidity. The average volume today is approximately 7.5 million shares. After the split, it could rise four-fold to around 30 million, which would tighten bid-ask spreads.

The liquidity improvement would also carry over to the options market. Additionally, the distance between strike prices will shrink, giving more flexibility in strike selection when building trades. With the lower share price, strategies like covered calls and naked puts become much easier to build because of the lower capital requirement.

Companies don’t announce splits unless they believe their share price will continue rising. They’re signaling to the market that business is good and more profits are on the horizon.

Volatility Expectations

Nvidia (NVDA) stock trend is bullish ahead of earnings
Source: The thinkorswim® platform from TD Ameritrade

NVDA stock heads into tonight’s earnings perched just shy of its all-time high. The 200-day, 50-day, and now 20-day moving average are all pushing higher to confirm the trend is up, and bulls are in control. Despite booming in value over the past few years, Nvidia hasn’t seen much volatility during its quarterly reports. As a result, the options board is baking in relatively tame expectations.

The market maker move is $25, which translates into a gap of 4%. The average true range (ATR) is currently $20.88, so the gap isn’t expected to be all that different than a typical day. As a result, strategies like short strangles, or iron condors, where you are shorting volatility and betting the stock gaps less than expected aren’t offering that wide of a profit range.

But Nvidia’s history of not moving much also makes it hard to swing long volatility strategies like long straddles or strangles into the event.

That leaves traders with two choices. First, you can pass on trading the report and see what kind of tradable patterns emerge afterward. Second, you can go with the trend and lean bullish. If we gap lower, I suspect the looming split will help minimize the damage and bring dip buyers quickly in.

Bull Puts

To increase the odds of success, I like bull put spreads. We’ll go out to July to build a wider profit range.

The Trade: Sell the July $550/$540 bull put for $1.65.

The max gain is $1.65 and will be captured if NVDA sits above $550 at expiration. The max loss, and initial trade cost, is $8.35.

On the date of publication, Tyler Craig held a long position in NVDA. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

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