To The Moon

Last night, chip stocks blew up.

First, Europe's lithography giant $ASML Holding NV(ASML)$ 's shares plunged 10%, and then in the USA, $NVIDIA Corp(NVDA)$ fell 6%, while $Advanced Micro Devices(AMD)$ tumbled 10%. The broad decline in chip stocks dragged down the $NASDAQ(.IXIC)$ by 2.7%, marking its biggest one-day drop since December 2022.

What's next for the US stock market?

In the first half of the year, The Magnificent 7 stocks fueled the market rally, pushing their valuations skyward. Now, with their pullbacks, can the US stock market continue its ascent without their momentum?

Scott Rubner, a strategist at Goldman Sachs, advises against bottom-fishing in US stocks right now, suggested:

The market correction is just beginning and that the S&P 500 index will see further declines. Historical data since 1928 indicates that market returns tend to shift gears around July 17th, and August is typically the month with the heaviest outflows from passive funds and mutual funds.

Jonathan Krinsky, an analyst at BTIG, echoes this sentiment,

argued that the US stock market is nearing a typical bull market endgame. Despite positive sentiment, survey and trading indicators suggest that a shift from large-cap tech to cyclicals and small-caps, though encouraging, seems premature in its swiftness. Even if this shift persists, new leaders may not emerge before a deeper market correction.

If the US stock market continues to decline, what options strategy should investors use for shorting? Given the current market climate, directly shorting stocks may carry risks. Instead, investors can opt for limited-risk shorting strategies like a Bear Call Spread.

What is a Bear Call Spread Strategy?

Bear Call Spread Option Strategy | Bear Call Spread Strategy Example

A Bear Call Spread is an options strategy used by traders who anticipate a decline in the underlying asset's price within a specific timeframe, while aiming to limit their risk exposure.

Specifically, a bear call spread involves buying a call option at a specific strike price and simultaneously selling the same number of call options with the same expiration date but at a lower strike price.

Case Study: Shorting NVIDIA

Taking short Nvidia as an example, the current price of Nvidia is $119.6, assuming that investors expect Nvidia to fall to about $100 on August 16, investors can use the bear call spread strategy to short Nvidia at this time.

Step 1: Sell a call option expiring on August 16 with a strike price of $100.

Step 2: Buy a call option with the same expiration date and a strike price of $117. The bear call spread is now set up.

After the strategy is established, the strategy achieves a maximum profit of $1,190 when the stock price of Nvidia is below the short call exercise price (below $100) at the expiration of the option. The break-even point is $111.8.

When the stock price is higher than the long call strike price (above $117), the strategy reaches its maximum loss, with a maximum loss of $512.5.

In the aftermath of chip stock declines, if investors remain bearish yet uncertain about the future trajectory, adopting a bear call spread strategy can be prudent. The primary advantage of this strategy lies in its risk mitigation (the long call at a higher strike price helps offset the risk of the short call at a lower strike price).

While theoretically, shorting stocks exposes investors to unlimited risk if prices rise, a bear call spread significantly reduces this risk compared to direct shorting.