Strategic Cash-Secured Put Option Guide for Nvidia Investors

What is happening with Nvidia?

Nvidia's stock price recently fell below 100, driven by a broader sell-off in the tech sector and a 3-month delay in the release of its next-generation Blackwell B200 chip. This setback has raised concerns among investors, contributing to the stock's decline. However, it has since rebounded from the lows as investors saw the dip as an opportunity to accumulate shares ahead of its earnings report. 

The chip maker is also set to face tougher competition from its peer, Advanced Micro Devices (AMD). AMD is acquiring ZT systems, a designer of data-center equipment for nearly $5 billion to compete with Nvidia as the next generation of data centres housing more powerful AI chips. Nvidia CEO Jensen Huang has addressed concerns about the competition by emphasizing the company's advantage in total cost of ownership, which includes indirect factors such as power and cooling demands.

Nvidia remains the most critical player in the AI space with its competitive edge and ability to stay ahead of the curve. Goldman Sachs reaffirmed its bullish stance on Nvidia ahead of the earnings release, citing strong demand for artificial intelligence from cloud service providers and enterprises.

What can you do?

Investors looking to increase their stake in Nvidia and wish to earn some income but feel that there could still be some downside in the short term may consider selling cash-secured put options on Nvidia. This strategy allows investors to potentially acquire Nvidia shares at a lower price while earning a premium. Investors must set aside the cash required to purchase the stock if the option is exercised.

Illustration:

1. With Nvidia’ stock price at $127.25 on 21 Aug 2024, selling a put option with a $105 strike price (if you are comfortable buying your Nvidia shares at $105) for 1-month expiry (30 days) will yield a total premium of $203.00. ($2.03 x 100 shares).
2. This gives an annualized yield of 19% (2.03/127.25) x (360/30).
3. If Nvidia’s price stays above the strike price of $105 at expiry, the option will expire worthless, and the investor gets to keep the premium with no additional obligations.
4. If Nvidia’s price falls below the strike price of $105 at expiry, the investor is obligated to buy 100 shares at $105. The investor still gets to keep the option premium and owns the stock at a price that they were comfortable buying at.

Note:

1. Please note options trade in lot sizes of 100 shares. When an investor sells 1 lot of put option, they are selling a put option on 100 shares.
2. If the investor wishes to receive a higher premium, the investor could choose an option with a similar strike price and a longer expiry.
3. If the investor is only willing to buy the stock at a lower price but still want to receive a relatively similar premium, the investor could choose an option with a lower strike price and a longer expiry.

Advantages of Cash-Secured Puts

1. Generates passive income. Selling a cash secured put option generates an income via premiums that can supplement the overall return of a portfolio.
2. Recurring income. Investors can repeatedly sell cash secured puts on the same stock, generating recurring income as long as the stock stays above the strike price.

Risks of trading Cash-Secured Puts

1. Potential losses. If the stock price falls significantly below the strike price, investors may be obligated to buy the stock at a higher price than its then market value, minus the premium earned.
2. Early assignment. Investors may be assigned the stock before the expiration date, especially if the stock price falls significantly below the strike price. It is important to set aside adequate cash to take delivery of the stock at all times.
3. In the example above, it is possible that the stock falls well below $105 before the expiry but on expiry stays above $105. Without the option, the investor might have bought the stock below $105 but because of the cash-secured put option, the investor might miss out on the eventual upside of the stock.

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