Nvidia continues to show strong ratings despite its lackluster performance in the last six months. Today, I want to look at a strategy with a slightly bullish outlook in Nvidia stock and a substantial profit zone on the downside.
The strategy is called a broken wing butterfly. This time, we'll use puts because the short strike in Nvidia stock gets placed below the stock price. This helps to reduce assignment risk.
On Monday, Nvidia stock rallied sharply and tested upside resistance at the 50-day moving average.
Nvidia Stock Today: The Broken Wing Butterfly
With a regular butterfly option trade, you normally place the wings an equal distance from the short strike. But with a broken wing butterfly, we leave a larger gap on a particular side. This results in less risk on one side and more risk on the opposite side.
Let's take a look at how a broken wing butterfly trade might be set up on Nvidia stock, based on recent trading:
- Buy 1 March 21-expiration 100-strike put @ 3.10.
- Sell 2 March 21 120 puts @ 6.10.
- Buy 1 March 21 130 put @ 9.40.
Notice that the upper strike put stands 10 points away from the middle put with a 120 strike price. The lower put lies 20 points away.
This broken wing butterfly trade will result in a net debit of $30 per set of contracts, or the maximum loss if the stock finishes above 130.
Maximum Gain Vs. Potential Loss
If all the puts expire worthless, that leaves the trader with a $30 loss. On the downside, the maximum loss can be calculated by taking the difference in the widths (10) multiplied by 100, plus the premium paid.
That gives us (10 x 100) + 30 = $1,030. Therefore, we can calculate the maximum gain as (10 x 100) - 30 = $970.
The ideal scenario for the trade is that Nvidia stock stays relatively flat and finishes somewhere between 110 and 130.
The trade starts with a delta of 6, so has a slightly bullish bias to start, but that will flip to a negative delta closer to expiry if the stock is still above 130.
A Stop-Loss Strategy
In terms of risk management, I would set a stop loss at 20% of the capital at risk, or if Nvidia stock breaks below 110.
According to IBD Stock Checkup, NVDA ranks third in its group and has a stellar Composite Rating of 98, a perfect EPS Rating of 99 and a Relative Strength Rating of 88.
Remember that options are risky and 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, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
