Shares of Nvidia (NASDAQ:NVDA) have been on a major run lately. NVDA stock is trading just off all-time highs after rallying $200 points from the recent lows just a month ago on May 19. Certainly some of the lift was warranted following the recent earnings report given the solid earnings beat. Nvidia has now come too far, too fast. Look for the red-hot rally to cool over the coming weeks.
The move to all-time highs in NVDA stock caused the usual cavalcade of upgrades from analysts. Bank of America just upped the price target on NVDA stock from $800 to $900. Jefferies had previously raised their price target from $750 to $854. Even with these upgrades the average analyst price target is $758.78 with a strong buy. It rose above that level on June 17 and has since mostly stayed above it.
The fundamentals are definitely getting a little stretched for NVDA stock at current levels. The trailing-12-months price-to-earning ratio (TTM P/E) stands at 89.3 and is nearing the richest multiple in the past decade.
The last time Nvidia carried such a lofty valuation was in mid-April. This marked a meaningful top in NVDA stock. The current P/S (price to sales) ratio of 24.74 is also extremely rich and is near the 10-year high of 25.04. It’s hard to envision a further multiple expansion to buoy the stock higher from here. Valuations actually do matter at some point.
Technical Take On NVDA Stock
NVDA is extremely overbought on a technical basis. The 9-day RSI has risen above 80. MACD just breached the 10 area before weakening. Momentum also reached an extreme as well before finally pulling back. Shares are trading at a big premium to the 20-day moving average. The previous three instances when these indicators aligned in a similar fashion marked a significant short-term top in NVDA stock.
Source: The thinkorswim® platform from TD Ameritrade
More importantly, NVDA had a key reversal day on June 18. Nvidia stock raced to all-times highs at $775 intra-day only to reverse course and drop over 30 points to close lower on the day. It followed a similar pattern on June 24. This type of key reversal pattern is often an indication the previous trend has come to an end. The buyers have become exhausted and the sellers have taken control. It is even a more powerful signal given the magnitude of the prior move higher in NVDA stock.
My prior article on NVDA stock from May 6 had a more bullish tone. Shares were trading near $600 at the time, and I recommended an out-of-the money bull put spread trade, which proved to be profitable. Nvidia stock has rallied 25% since that time, and my outlook has now become more bearish. Price does matter.
Shorting NVDA stock outright is both risky and expensive. Shorting just 100 shares would require roughly $38,000 in margin. Fortunately, the options market provides a lower-cost way to be a seller on a further leg higher.
Selling an out-of-the money bear call spread makes probabilistic sense. It allows one to position bearishly on an overvalued and overbought NVDA stock in a defined risk manner. It is important to lower risk in this type of market environment.
The Nvidia Trade
Sell NVDA Aug $820/$825 call spread for a $1.35 net credit.
Maximum gain on the trade is $135 per spread. Maximum risk is $365 per spread. Return on risk is 37%. The short $820 strike provides a 6% upside cushion to the $771.22 closing price of NVDA stock. It is also well above the all-time high at $776.80. The spread expires before earnings, currently estimated for late August. This eliminates any earnings related risk.
On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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