This Industry Might Not Be Ready to Turnaround Yet
It was just a year ago. Bitcoin was flying high. Traders were pushing into the cryptocurrency markets. They were envisioning a digital future which meant they were looking beyond cryptos. They saw initial coin offerings as a way to fund startups. Smart contracts would make every transaction simpler.
They saw crypto mining as a way to create money. And, they saw distributed ledgers as the key to the widespread acceptance of crypto in the real economy. And, that was the big payoff. Having crypto competing against dollars and euros would make cryptos worth trillions.
But, to get to the digital future, there needed to be a digital infrastructure that could manage the transactions. Miners needed more and more powerful machines. Ledgers required more and more computing power.
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These needs were obvious and many rushed into mining as an investment. They could run computers to find new crypto coins and the more computers they had, the more coins they could mine which in the end meant more money. It seemed like a perpetual money machine and many bought in to the dream.
We don’t know how the dream ends, yet. We know many investors and miners have lost money but there’s still time for a digital future. Some just got ahead of themselves. That means some traders also got ahead of the market and bid prices of computer and chip makers to unrealistic prices.
Now, the prices of stocks caught up in the crypto bubble are dropping back towards fair values based on fundamentals.
Nvidia Could Need Time to Recover
Yahoo Finance reported,
“Nvidia earnings (NASDAQ:NVDA) came in late in the day on Thursday afternoon, sending shares plummeting as the company’s earnings were ahead of the mark, but its revenue for its previous quarter and revenue guidance for the current quarter were below what analysts were calling for.
The graphics processing units manufacturer said that its earnings for its third quarter of fiscal 2018 came in at $1.84 per share on an adjusted basis. Analysts were seeing the company’s quarter as amassing adjusted earnings of $1.71 per share, according to data compiled by Refinitiv.
Nvidia said that its revenue for the period came in at $3.18 billion, which was stronger than the $3.24 billion that the Wall Street consensus estimate called for, according to data compiled by Refinitiv. The sales figure also increased about 21% compared to the year-ago quarter.
In terms of guidance, the company said that it is calling for revenue of $2.70 billion for its fourth quarter of its fiscal 2018, plus or minus 2% and when excluding certain items. The figure is below the Refinitiv revenue guidance of $3.40 billion.
The chipmaker suffered during the quarter due to its cryptocurrency mining products taking a hit.”
NVDA stock plummeted on the news.
The trend is now down in the stock and the price target is near $100 based on the weekly chart.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
A Bear Call Spread in NVDA
For NVDA, we could sell a December 21 $165 call for about $3.65 and buy a December 21 $170 call for about $2.68. This trade generates a credit of $0.97, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $97. The credit received when the trade is opened, $97 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $403. The risk can be found by subtracting the difference in the strike prices ($500 or $5.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($97).
This trade offers a potential return of about 24% of the amount risked for a holding period that is about four weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if NVDA is below $165 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $ for this trade in NVDA.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.