If I were to isolate one stock as ready for shorting in today’s market, it would beNvidia Corporation (NASDAQ:NVDA). At the same time, I wouldn’t mind owning NVDA stock … if the price were right.
The good news? There’s a way to satisfy both my bullish and bearish desires, and with little risk to boot.
Following its recent earnings blowout, NVDA stock has become increasingly popular with analysts and momentum traders alike. Unfortunately, when optimism rises to a crescendo-like chorus of nothing but blue skies ahead for investors, that’s typically when gravity and rich valuations enter stage left.
This looks like the situation in Nvidia right now. Not only have shares gained a whopping 38% to hit all-time highs since topping profit views by 26 cents earlier this month. They’re also up a massive 180% year-to-date.
No doubt the narrative surrounding NVDA stock has caught investors’ attention. Whether it’s gaming, autonomous vehicles, virtual reality, cloud computing and the internet of things (IoT), Nvidia seems to be in all the right growth markets.
But the story in Nvidia stock isn’t altogether fresh, either.
I wrote about Nvidia’s positioning and prospects back in January when shares were in the high $20s and the mid-$30s in March. Now NVDA trades for more than $93.
Was Nvidia really so cheap to have afforded a triple in price in such a short span of time? Have the company’s prospects really changed that much over that same period? It’s doubtful.
To a degree, NVDA stock was more affordable earlier this year. But the real story investors are currently buying is priced at much riskier levels.
NVDA Stock Monthly Chart
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Nvidia stock is expensive by several metrics, including a price-to-earnings ratio of 35, price/earnings-to-growth ratio of 1.57 and price-to-sales ratio of 8. Moreover, NVDA is seeing a linear price swing higher, and shares are in their seventh month outside the stock’s upper monthly chart Bollinger Band.
All this points to a risky purchase at current levels.
The combined hefty multiples and current fervor make NVDA stock susceptible to a price decline of perhaps as much as 30% without causing too much alarm for long-term investors.
NVDA Stock Bearish (into Bullish) Butterfly Strategy
Don’t get me wrong, I still like Nvidia. I simply wouldn’t buy it near current prices. One strategy which can allow an investor to profit on a NVDA correction and buy shares on weakness is a bearishly positioned put butterfly.
Reviewing NVDA’s options, an “uneven” Jan $85/$80/$70 put butterfly fits the bill. Priced for a small debit of 5 to 10 cents, this position will provide increasing profits of nearly $5 per contract on an expiration basis if NVDA were to fall from its current price of $93.23 to $80.
Maximizing the return at $80 lines up with a corrective move of around 15.5%. A steeper drop into the expiration date will continue to provide profits down toward $75. At that level — which amounts to a correction of 21% in NVDA — the trader breaks even.
As the trader is short two $80 puts versus long one $85 put, if NVDA is below the strike at expiration the trader should expect to be assigned and net long shares at $80. That’s a good thing if, like us, you’re ultimately inclined to buy NVDA at more affordable levels.
Even better, since the position would have captured the full $5 profit of the $85/$80 bear put spread minus the small debit, the trader is really acquiring NVDA stock near $75.
Investment accounts under Christopher Tyler’s management do not currently own positions in any of the securities or their derivatives 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.
