$NVIDIA Corp(NVDA)$ has recently faced a sharp decline, with its stock dropping over 17% in just nine trading days, wiping out nearly $550 billion in market value and shaking up the US stock market. Nvidia's 30-day volatility has reached its highest level since mid-2022.
Wall Street analysts are questioning: Is now the right time to buy Nvidia on the dip?
Here are the five main reasons behind the Plunge:
1. Antitrust Risks: The US DOJ has issued subpoenas to Nvidia and related parties to investigate possible antitrust violations. Although Nvidia denies receiving the subpoenas, concerns about increased regulatory scrutiny in the AI sector are weighing on the stock.
2. Chip Release Delays: Nvidia’s new AI chip, Blackwell, has been delayed due to design flaws, potentially affecting clients like Meta and Google. Morgan Stanley expects the delay to be brief, but the market's reaction has been negative.
3. Lower Earnings Forecast: Nvidia’s Q3 revenue is projected to be $32.5 billion, below some analysts' expectations, with growth rates falling below 100% for the first time. The lack of clear guidance on capital expenditure and investment returns has shaken market confidence.
4. Industry Cycle and Weak Demand: The semiconductor industry is entering a late-cycle phase, with weak chip sales data. The market's tepid response to positive news reflects concerns about future demand.
5. Shareholder Sell-off Concerns: Although rumors of Pelosi selling Nvidia stock have been debunked, recent sales by CEO Jensen Huang have raised concerns among shareholders.
Opinions on Wall Street are divided. Bulls argue that Nvidia’s dominant position in the AI chip market and strong demand make it a strong buy. Wedbush analysts even call Nvidia’s GPUs the “new oil,” driving the AI revolution. Bears, however, believe market expectations for Nvidia are too high, with a lack of new growth drivers and future uncertainties.
For investors looking to go long while controlling risk, a Ratio Spread strategy could be a good option.
What is a Ratio Spread?
A Ratio Spread is an options strategy where traders buy at-the-money (ATM) or out-of-the-money (OTM) call or put options and then sell two or more of the same type of OTM options. Traders can use this strategy with calls (Call Ratio Spread) or puts (Put Ratio Spread).
If a trader is slightly bearish, they might use a Put Ratio Spread. If they are slightly bullish, a Call Ratio Spread could be the choice. Typically, the ratio is one long option to two short options, but this can be adjusted. The maximum profit in a ratio spread is the difference between the strike prices of the long and short options, plus any net credit received.
Traditional spreads have capped profits on the upside. To overcome this, you can use a Call Ratio Backspread, which is a call options strategy that involves buying a call option and then selling a call option with a different strike price but the same expiration date, using a ratio of 1:2, 1:3, or 2:3.
Since you hold more long calls than short calls, this strategy can potentially offer unlimited upside profit. An investor using a Call Ratio Backspread will sell fewer calls at a lower strike price and buy more calls at a higher strike price. This strategy aims to profit from a rising market while limiting potential losses.
Nvidia Call Ratio Backspread Example
Here’s how an investor can set up a call ratio backspread strategy for Nvidia to maximize potential gains if the stock price rises:
Step 1: Buy Call Options. The investor buys 3 call options with a strike price of $120, expiring on October 11, 2024. Each option costs $274, for a total cost of $822. These calls aim to capture higher profits if Nvidia’s stock rises above $120.
Step 2: Sell Call Options. To offset some of the cost of the bought calls, the investor sells 1 call option with a strike price of $106, also expiring on October 11, 2024. Each of these sold options brings in $807, totaling $807in revenue. Selling this call generates initial profits if the stock price doesn’t rise, but could lead to some losses if it does.
Maximum Potential Profit and Loss
If Nvidia’s stock surges above $120 by expiration, all bought calls will be in the money, and the investor can gain significantly. The loss on the sold $106 call will be limited since it’s only one contract and has a lower strike price compared to the bought calls.
The maximum potential loss is the net cost of the strategy, which is just $8. The revenue from the sold call nearly offsets the cost of the bought calls, making potential losses quite limited.
For the strategy to break even, Nvidia’s stock price must rise enough for the value of the 3 bought calls to cover the loss from the sold call. With a net cost of only $8, reaching the Break-Even Point is relatively easy.
If Nvidia’s stock is at $140 on expiration:
- Buying 3 Call Options at $120 Strike Price:
Profit per option: $(140−120) × 100 = $2,000
Total profit: 3 × $2,000 = $6,000
- Selling 1 Call Option at $106 Strike Price:
Loss per option: $(140−106) × 100 = $3,400
Total loss: $3,400
- Net Profit Calculation:
Net profit = $6,000 (total profit) - $3,400 (total loss) - $8 (net cost) = $2,592
In this scenario, with Nvidia’s stock at $140, the net profit from the strategy would be $2,592.
This example shows how a ratio spread strategy can significantly adjust profit potential. By tweaking the number of options bought and sold, you can fine-tune your bullish or bearish stance. The Call Ratio Backspread is great for capturing big gains when you’re right about the market direction, while limiting losses when you’re wrong.
Compared to a double long strategy, it suffers less from time decay; and compared to a single long strategy, it offers a chance to profit even if the market doesn’t move exactly as expected. It’s a solid strategy to consider for your investment portfolio.
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