"Big waves are a whole different ball game. You're riding a wave with an immense amount of speed and power, generally over 10 meters. On the face of the wave, obviously, life and death thoughts start to happen" Kelly Slater
Big wave surfing is quite different and quite a bit more dangerous than regular surfing. Whereas a leash is normally a surfer's saving grace in the water, and keeps him with his board, when surfing walls of water that are thirty feet or higher, the leash might drown you. So many surfers instead to use specialized stirrups. This way, they won't be dragged down by a board should disaster occur.
When dealing with market darlings that have high valuation, the rules can be similarly distorted compared to 'normal' stocks. In big wave surfing, a tiny dent in the fins can cause a major wipe out, just like a slightly underwhelming guide can cause a massive sell-off for Magnificent Seven stocks. But being too tied to valuation, just like a surfing leash, can drown your returns.
We've seen this earnings season that several Mag 7 names sell off after putting up amazing numbers. So, when you're playing earnings, it is always smart to define your risk if you're using options. Otherwise you might "drown," or lose 100% of your investment. This is why, given a pernicious risk backdrop, I think a risk-defined trade on Nvidia trade is wiser than a straight bullish bet.
I am really betting more on volatility. I think Nvidia won't go much lower than here, and given the positive jobs news today and other positive economic news I expect coming, I do expect a melt-up going into earnings, particularly since the carry trade catalyst has been essentially neutralized by the BoJ.
For several reasons, given the backdrop of this market and record high spikes in volatility, I think the catalyst of Nvidia earnings will be particularly important later this month. I also think they have a high chance of being in the upper bound of price reactions, whichever way the price goes after the report.
Nvidia is a high beta stock, and while this is often priced into options markets right before earnings, if you get a bit of a head start then you can benefit from the people who turn in their homework late without even waiting for the catalyst to actually play out. In the event of such a flush, you can sell half of your calls to lock in some gains and mitigate risk.
Nvidia has become the most controversial stock in the market due to its prolific rise. Recently bears have been thumping on its weakness. But it is the last prodigious earnings report of the season. Remember that Nvidia's AI driven earnings beats helped start this bull market, and I'm giving you a trade to bet that it's earnings later this month will help reignite it after a shaky period.
The long strangle is a multi-leg options trade consisting of one OTM put option and one OTM call option. However, since I'm bullish on the stock, I'm going to do two call options for every one put option. This will also give you the flexibility to control your risk going into the event. It also speaks to the bullish bias of my analysis on the stock.
Nvidia options, as with most companies, tend to have an implied volatility flush going into earnings. So, if this is the case, then you can sell half the calls at a profit before the earnings are even announced. This can help mitigate risk in the event of poor guidance or an earnings miss. Furthermore, Nvidia's put/call ratio is high suggesting that an end to selling could be near.
I am very bullish on Nvidia and their earnings potential. I think the stock is fundamentally undervalued after the latest round of selling. Still, given the recent spike in volatility and skittish investors I think having a put option in the mix isn't the worst idea in the world.
The Trade
This is a bit of a complicated trade. The long strangle options strategy is a strategy that benefits from volatility, regardless of the direction of price movement. It consists generally of buying one OTM call and one OTM put. I have modified it slightly, but both sides of the trade are roughly equivalent in price.
If the stock stays within a range that doesn't cover the cost of the options, then the trade loses money. If the stock moves enough in either direction, then the trade is profitable so long as it covers the expense of the other losing side.
So, for this trade I will modify it a bit though. Since Nvidia is closer to the lower end of its 52 week range, I think there is a higher than average qualitative chance for a large spike. I say this largely based on faith in the company's management and having covered the stock extensively for more than a year. I think the appreciation potential for OTM call options is undervalued right now. Thus, I am going to suggest buying two calls for every one put.
Nvidia typically enjoys an implied volatility flush going into earnings, which are still a couple weeks away. So, if you're more risk averse you can sell half of the calls before the earnings are even announced. This can significantly mitigate your risk going into the trade.
There is a reason why I'm confident in Nvidia beating this quarter: they have continued to deliver and, so far, demand associated with their wares has shown no signs of slowing. The firm has one of the most durable competitive advantages on Earth:
Nvidia's revenue tripled on a YoY basis.
Nvidia's data center quadrupled on a YoY basis.
Importantly, cloud providers are becoming major customers for the company's chips and experiencing a significant return on investment, leading to a virtuous cycle in demand underestimated by many analysts.
However, the CAPEX race for Artificial Intelligence and the proof that investment is earning thoughtful users of Nvidia's crucial wares will likely only increase demand for the chips already booked up well into 2025.
Nvidia's core customers are the strongest customers in the world and relatively insulated from inflation risk.
The adjusted gross margin came in at 78.9% for the quarter.
The firm is a monster, and despite many uninformed folks postulating the Nvidia is in a bubble, the price gains are fundamentally justified based on earnings. The below is Nvidia's forward earnings estimates versus price.
Ok, so here is the bullish earnings trade.
Buy one September 13th $96 put on Nvidia (currently priced at around $6.10).
Buy two September 13th $120 calls for every put you buy (currently priced around $3.05.)
The reason for this is that the Nvidia options skew typically favors call options compared to puts. However, after the recent selling, puts are selling are enjoying a rare premium. The put/call ratio for Nvidia is near yearly highs. I think this trade will pay off very well.
If Nvidia crashes on recession fears or a Fed error, the put will control your losses. However, if Nvidia experiences a price rebound like I expect, the further OTM calls will appreciate nicely and quickly. Either way, the trade has some room for error and will benefit from Nvidia's status as one of the highest beta stocks in the market.
