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Nvidia (NVDA) stock has recovered from its lows but now its put option premiums are sky-high. This is ahead of its upcoming earnings release on Nov. 21 for its fiscal quarter ended Oct. 30. That makes them ideal to sell short for extra income.
As of morning trading on Monday, Nov. 13, NVDA stock is at $487.89, up near its highs since the end of August when it last reported earnings. One reason is that estimates for the company's performance are for amazing growth.
For example, analysts project revenue will rise to $16 billion, up 170% from 5.93 billion a year ago. This will also mean an increase of over 18.3% from last quarter's $13.5 billion if it occurs. Moreover, non-GAAP earnings per share (EPS) is projected to leap by 481% from 58 cents last year to $3.37 this past quarter. That would also be 24.8% higher than last quarter's $2.70 EPS.
So, in short, expectations are sky-high, which has pushed NVDA higher.
High Put Premiums
However, contrarians expect there could be a “sell on the news” effect with the earnings release. That means there could be a quick downward move in NVDA stock after the earnings, regardless of whether it is merited or not.
That, in return, has pushed up its put option premiums. I discussed this in my recent article on NVDA stock on Nov. 6, “Nvidia's FCF is Powerful and Could Push NVDA Stock Higher.”
For example, for the period ending Nov. 24, which is right after the earnings release, NVDA puts at the $485 strike price, which is less than 1% below the spot price, trade for $21.25 per put contract. That represents an amazingly high yield of 4.38% (i.e., $21.25/$485.00).
Shorting Near-Term OTM Puts for Income
It does not make sense to short this out-of-the-money (OTM) puts for income, even though the breakeven point is $463.75, or 4.85% below today's price.
By contrast, to be conservative, investors might want to short the $465 strike price. That is about 4.9% below today's price. The premium is lower at $12.55, but the yield is still high at 2.70% (i.e., $12.55/$465.00).
Moreover, the investor's breakeven price is more conservative at $452.45 (i.e., $465-$12.55), or about 7.3% below today's price.
Here is what this means from a practical standpoint. If an investor secures $46,500 in cash and/or margin with their brokerage firm, they can enter a short put trade. For example, by doing an order to “Sell to Open” 1 put contract at $465 at the bid price of $12.55, the account will immediately receive $1,255.00
Downside Risk
That works out to 2.70% of the $46,500 invested in this 11-day trade. No matter what happens the investor keeps this income. However, the risk is that if NVDA stock falls to $465.00 on or before Nov. 24, and the investor does not sell, his secured $46,500 in cash/margin will be used to purchase 100 shares at $465.00 per share.
That may or may not result in an unrealized loss. Nevertheless, the investor will now own 100 shares and this can be held until the stock rises. Or the investor can sell OTM calls against those shares.
Keep in mind that there is usually a very strong move down in the stock after earnings. But it has tended to rise after that, as investors begin to look forward to higher growth prospects. If that happens this time, even though the short play is out of the money, the investor may or may not make money. But if this trade is repeated over time, it will likely lead to good income.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
