Nvidia dropped over 3% Tuesday and is showing high implied volatility.
As option traders, we can take advantage of that high volatility by selling a short strangle.
A short strangle involves selling an out-of-the-money put and an out-of-the-money call with the same strike price and the same expiration date.
This trade generates a large amount of premium for the option seller, but it does come with risks. A short strangle is an unprotected trade, sometimes referred to as a "naked" trade. Naked options can be risky because they expose the trader to potentially unlimited losses if the stock makes a big move.
However, if the trader is right and the stock trades sideways, the trader gets to keep the full premium.
Assuming traders believe that Nvidia stock will trade sideways over the next few weeks, they could look to sell a Nov. 15-expiry, 100 put and a Nov. 15, 140 call.
The 100-strike put could be sold for around $2.20 and the 140-strike call could be sold for around $1.75.
Nvidia Trade Could Generate $395
Selling those two options would generate a total of $395 in premium. That is the maximum possible gain on the trade if Nvidia stock closes between 100 and 140 on the day of expiration.
To work out the break-even price of the trade, take the lower strike price of 100 minus the total premium received of $3.95. That results in 96.05.
Then on the call side, take the call strike and add the premium, which gives 143.95.
This is a short vega trade, which means if implied volatility increases early in the trade, losses could occur.
Short strangles are an advanced option strategy, so if all that sounds confusing, it's best not to trade them.
Losses Could Be Unlimited
With a trade like this, the potential losses are unlimited and a lot higher than the potential gains. So traders should be very confident that the stock is going to remain flat over the course of the trade.
A stop loss could be placed at the break-even points.
According to the IBD Stock Checkup, Nvidia is ranked No. 1 in its industry group. It has a Composite Rating of 98, an EPS Rating of 99 and a Relative Strength Rating of 97.
Nvidia is set to report earnings on Nov. 19, so this trade should have no earnings risk.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
