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Simple stock alternative with defined risk - Nvidia (NVDA)
3 min read

Simple stock alternative with defined risk - Nvidia (NVDA)

Simple stock alternative with defined risk - Nvidia (NVDA)


We've been highlighting some earnings events over the past few weeks and generally compare debit and credit put spreads to single leg options, highlighting breakevens, probability of profit and risk reward between the various strategies. I wanted to highlight one use of a debit call spread that can closely mimic stock, but with defined risk. This can be particularly helpful into uncertain events like earnings, but it can also be an effective way to gain stock like exposure in high dollar stocks with a much lesser use of funds.

The Set-Up

We're going to be using Nvidia (NVDA) for illustration. NVDA is a stock on a tear, with a bounce from its March lows below $200 to $360 today. The 3 month chart shows the extent of the move higher and the expected move over the next 3 months. From OptionsAI technology:

That's the type of chart you wished you owned the past two months. However, with an event coming (after the close Thursday), the risk/reward of continuing to own the stock (or any new longs) get's a little dicey.

Ways to Play

One way to define risk, and limit the use of funds in comparison to owning stock, is to establish a call spread that has a breakeven near where the stock is trading. Here's a bullish price target in June, targeting a move higher to $400:

And the trade comparison produced by OptionsAi technology:

The comparison is based on buying 100 shares of stock, which clearly costs a lot of money. Let's focus on the Buy Call Spread (360/400) trade. That trade costs ~$1,472 meaning a breakeven of $374.75 in the stock. The higher breakeven is clearly a tradeoff as the probability of profit is 44%.

But what if we spent a little more and got that percentage closer to buying stock, but at a fraction of the cost?

Here we edit the lower strike of the spread to make the long call more in the money, and produce a breakeven roughly where the stock is trading:

The net result (a 330/400 70 wide call spread) is the equivalent of 100 shares of stock up to $400, with potential losses like stock below, but only down to $330 (not below). And for just $3200 rather than $36,000 in the stock. The trade off is that potential gains are capped at $400 in the stock, but on the flipside, not only is risk defined below, it's actually at a level inside the bearish consensus. In other words, you could lose more on a consensus move lower if you bought stock.

This is a way to use a very simple option spread to mimic stock gains and returns inside a range, without giving up probability of profit on out of the money options. In fact, because it's a spread it's using the high vol into the event to its advantage by selling the 400 calls. Of course it's not 100 deltas right out of the gate but with just a month until expiration and what is likely to be a vol crush after the event it's a great way to play for $400 without risking too much if NVDA (or any similar stock) disappoints or gets dragged down by a market reversal over the next few weeks.

And lastly, entry timing on a trade like this should be thought of in the same way as stock. A trade like this establishes a breakeven right where stock is. You want that breakeven to be where you actually want to own stock, or a point where you'd rather trade your shares for defined risk.

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