Nvidia stock regained a buy point Tuesday, is showing improving relative strength and looks primed to break out to new highs. Traders who think Nvidia stock will continue to rally could invest in a reduced risk way, with the use of options.
Here's a trade with favorable risk to reward that assumes Nvidia stock might move toward 155 in the next few weeks. We will look at a bullish diagonal spread which allows traders to get long on Nvidia stock without risking too much capital.
A bullish diagonal spread is a trade that involves buying a long-term call option and also selling a shorter-term, out-of-the-money call option against it.
We're looking for a controlled move higher over the next few weeks. Not a massive surge, but steady bullish action that allows the short call to decay while the long call retains value.
How The Bullish Diagonal Spread Works
Buying the Dec. 19 strike call at 135 will cost around $2,310. Selling the July 18 strike call option at 155 will generate around $260 in premium. That results in a net cost for the trade of $2,050 per spread. That's the most the trade can lose.
The estimated maximum profit is estimated at around $1,040, but that can vary depending on changes in implied volatility. The maximum profit occurs if Nvidia closed right at 155 on July 18. That represents a return of around 51%.
The idea with the trade is that if Nvidia stock trades up to around 155, the diagonal spread will increase, resulting in a net profit.
A bullish diagonal spread is a good way to gain some upside exposure on a stock. Investors don't risk too much if the move doesn't eventuate. Further, the combined position has a net delta of 39, which means the trade is roughly equivalent to owning 39 shares of Nvidia stock. But this will change as the trade progresses.
A suggested stop-loss level could use a close below the May 23 low of 129.16.
Nvidia Stock Ranks No. 2 In Its Industry Group
According to the IBD Stock Checkup, Nvidia stock is ranks second in its group. It also has a Composite Rating of 97, an EPS Rating of 99 and a Relative Strength Rating of 87. The best possible score in each rating is 99.
Also, Nvidia reported earnings last week, so this trade should not have any earnings risk if held to the July expiration. These numbers also assume you close out the entire trade by the time the July 18 expiration of the short call hits. An alternative play, since the long call would have more time, is you keep the long call and sell another call against it with another expiration prior to Dec. 19 for more income.
It's important to remember that options are risky and also that investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a masters in applied finance and investment. He specializes in income trading using options, and is conservative in his style. He also believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ.
