NVDA Vertical Credit Spread

[viruscore1]

Premium 2.38 , 20k margin, 11.9% return in about 3 months if held to expiry but I'll close out about 40 days before option expiry if I need the capital to roll into another trade and take some risk off the table.

Less than 17% chance it'll close below $175 strike

 

[TrustyJules]

Its pretty reasonable - there seems to be support around that line. Mind you the chances are 35-40% that you will get a 'touch' on the 175 strike if we use the rule of thumb that its twice the chance of ending below it. Keep enough margin on hand for that.

 

[MauricioMTL]

Your return calculation is misleading. It’s good to annualize it. 11.9% on 95 days is 45.7% on an annual basis.
I think 95 days is very far out. It is particularly a date after earnings. I would’ve chosen a date prior to earnings as the expiry.

 

[viruscore1]

Your return calculation is misleading. It’s good to annualize it. 11.9% on 95 days is 45.7% on an annual basis.
I think 95 days is very far out. It is particularly a date after earnings. I would’ve chosen a date prior to earnings as the expiry.

Good point but I will not hold this trade until expiry and into next earnings. You really think NVDA will drop 20% in 3 months with autonomous vehicle momentum? My plan is to hold this trade for about 2 months or 70% of max premium, which ever comes first and close out.

 

[TrustyJules]

Its already happened in the past year (a 20% drop) on 2/12 NVDA had a high of 120$ and on 2/24 a low 95 - I realise I am using an extreme here but just saying, these things can and do happen. Stocks that rocketed in the past couple of years like NVDA are certainly susceptible. Just look at the market reaction when AMD and INTC announced they were teaming up to beat NVDA - there was a very hefty reaction to something that was just a plan. Like I said earlier, your plan is not a bad one but far from infallible - my guess is that its odds on that you will have plain sailing but the likelyhood of at the very least seeing a test of your upper bound is far from zero.

 

[viruscore1]

Its already happened in the past year (a 20% drop) on 2/12 NVDA had a high of 120$ and on 2/24 a low 95 - I realise I am using an extreme here but just saying, these things can and do happen. Stocks that rocketed in the past couple of years like NVDA are certainly susceptible. Just look at the market reaction when AMD and INTC announced they were teaming up to beat NVDA - there was a very hefty reaction to something that was just a plan. Like I said earlier, your plan is not a bad one but far from infallible - my guess is that its odds on that you will have plain sailing but the likelyhood of at the very least seeing a test of your upper bound is far from zero.

Based on your analysis and conclusion did you short NVDA?

 

[TrustyJules]

Why would I do that?

I am merely commenting on your position - you asked whether a 20% drop is possible in the next three months. The answer to that is an emphatic yes. As I posted above as long as you are able to absorb the margin blow (position sizing is always key) you have a very decent position. Just saying its not at all excluded you may be tested on your upper bound - you state with great certainty there is an 80% chance of success, that still leaves a 1 in 5 chance of failure and a 1 in 3 (more or less) that your upper bound is tested. These are not hypothetical or very unlikely scenarios and you should be prepared to face them.

 

[viruscore1]

Why would I do that?

I am merely commenting on your position - you asked whether a 20% drop is possible in the next three months. The answer to that is an emphatic yes. As I posted above as long as you are able to absorb the margin blow (position sizing is always key) you have a very decent position. Just saying its not at all excluded you may be tested on your upper bound - you state with great certainty there is an 80% chance of success, that still leaves a 1 in 5 chance of failure and a 1 in 3 (more or less) that your upper bound is tested. These are not hypothetical or very unlikely scenarios and you should be prepared to face them.

Your point is obvious, any stock can reverse, stay flat or go up. As per option analyzer and NVDA momentum the chances are 18%. Your 20% drop "emphatical yes" is based on 1/5 chance. Make less sense than 4/5 chance it will stay above 175 strike.

 

[TrustyJules]

Ok you are not at all getting the statistics of this. The chance is 18% that the stock would end in 3 months below 175. There is a 36% chance that the 175$ will be touched based on statistical analysis. These are elements to take into account when setting up a trade like you have. A 20% drop - certainly for a stock like NVDA - is not at all out of the question this can happen and its not a black swan event.

So taking your statement that you will bail +- two thirds of the way in, this means you could do a trade like this (with modified strikes if appropriate) 6 times a year as you are in the market for 2 months for each trade. Based on the current prices you might exit for as little as 0.20$ net cost every time you are successful and lets presume you are successful 5 times out of 6 so that would net you $10,900 however we must also presume that the one failure will materialise.

For the sake of argument lets say NVDA would drop to 160$ - halfway to your lower bound. Presuming you bail out at 1 month before the end then you would lose ca. $12,700 (likely value of the spread is $15,000 to buy back minus $2300 credit received). This means that after a whole year of doing this you are coming out with a loss of $1900. Now to be fair these calculations are just the ones I did in my head and they should be made more exactly for example to allow for the fact its a 2 months not three months trade. However, your statement that

is based on 1/5 chance. Make less sense than 4/5 chance it will stay above 175 strike.

Is the one that doesnt make sense, the statistics shouldnt give you a false sense of security. If you showed me 5 doors and told me to walk through one of them. 4 doors give a million dollars and one of the doors leading to certain death; you wouldnt get me to go through any of them. The challenge with all such spreads is how to avoid taking the one big loser - all I was saying was that your setup seemed decent. That as long as you could manage the downside risk and position size it was a valid position. The 18% chance that it goes wrong shouldnt be underrated though - this is a very real percentage and the losers in credit spreads tend to be much bigger than the winners.

 

[viruscore1]

Ok you are not at all getting the statistics of this. The chance is 18% that the stock would end in 3 months below 175. There is a 36% chance that the 175$ will be touched based on statistical analysis. These are elements to take into account when setting up a trade like you have. A 20% drop - certainly for a stock like NVDA - is not at all out of the question this can happen and its not a black swan event.

So taking your statement that you will bail +- two thirds of the way in, this means you could do a trade like this (with modified strikes if appropriate) 6 times a year as you are in the market for 2 months for each trade. Based on the current prices you might exit for as little as 0.20$ net cost every time you are successful and lets presume you are successful 5 times out of 6 so that would net you $10,900 however we must also presume that the one failure will materialise.

For the sake of argument lets say NVDA would drop to 160$ - halfway to your lower bound. Presuming you bail out at 1 month before the end then you would lose ca. $12,700 (likely value of the spread is $15,000 to buy back minus $2300 credit received). This means that after a whole year of doing this you are coming out with a loss of $1900. Now to be fair these calculations are just the ones I did in my head and they should be made more exactly for example to allow for the fact its a 2 months not three months trade. However, your statement that

is based on 1/5 chance. Make less sense than 4/5 chance it will stay above 175 strike.

Is the one that doesnt make sense, the statistics shouldnt give you a false sense of security. If you showed me 5 doors and told me to walk through one of them. 4 doors give a million dollars and one of the doors leading to certain death; you wouldnt get me to go through any of them. The challenge with all such spreads is how to avoid taking the one big loser - all I was saying was that your setup seemed decent. That as long as you could manage the downside risk and position size it was a valid position. The 18% chance that it goes wrong shouldnt be underrated though - this is a very real percentage and the losers in credit spreads tend to be much bigger than the winners.

I am only holding this trade for about 7 weeks. If i'm down 20% I'm out and rolling into another trade. It's not "do or die" trade...