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What are your options - NVidia - earnings release - potential market reactions

What are your options - NVidia - earnings release - potential market reactions

Equities
Koen Hoorelbeke

Investment and Options Strategist

Summary:  Explore the potential market reactions to Nvidia's upcoming earnings release in this guide. From considerations before the release to understanding various market dynamics post-announcement, this article provides a selection of options strategies tailored for different outlooks. Whether bullish, neutral, or bearish, discover defined and undefined risk strategies that might align with your perspective.

Nvidia earnings release: potential market reactions


As Nvidia prepares for its next earnings release, the expectations are very high. The NVDA stock has seen a substantial rally in recent months. With the earnings date tomorrow, understanding potential market reactions can be essential for informed decision-making.

Before the earnings release: some considerations

  • Stock valuation: some investors may evaluate Nvidia's valuation, and considering a reduction in holdings if current price deemed (to) high. This can be done by either just selling some stock, or for the investor with options knowledge, unload them by selling ITM calls and optimize their profits along the way.
  • Protective measures: others, optimistic long-term but concerned short-term, might explore a modified collar strategy for protection where we protect the downside using a put vertical spread.
  • Pre-earnings trade: experienced traders could consider setting up a volatility-collapse strategy prior to the earnings to fully exploit the effects right after the earnings. This can be done either with an short iron condor or a short strangle. However due to the extreme expectations and very high implied volatility (see chart below), this should only be done by traders who have ample experience in this area.

Post-earnings release: understanding potential market dynamics

- Strong/positive earnings/outlook: strong earnings might lead some to explore call options (defined risk) or increase their positions. Have a look at the various bullish outlook strategies.
- Weak/negative earnings/outlook: weak earnings might lead to consideration of reducing holdings or exploring put options (defined risk). Also have a look at the various bearish strategies.
- Earnings aligning with expectations: if earnings align with forecasts, investors might maintain positions or await more favorable conditions. Here you might have a look at the neutral outlook strategies and/or the bullish outlook strategies.
(red line showing previous earnings)
Both before and after the earnings release, investors and traders have a choice of which options strategies to use. Below is a list of strategies that might work well together depending on the outlook before or after the earnings release. All strategies can be used before or after the earnings release; however, it's important to note that implied volatility often runs high leading up to an earnings announcement. This elevated volatility can affect the pricing of options and may influence the selection of strategies. While some may choose to act before the earnings release to potentially capitalize on this heightened volatility, others might prefer to wait until after the announcement when the implied volatility typically subsides. This approach allows for a more measured response based on the actual earnings results and the market's reaction, thereby aligning the chosen strategies with a clearer understanding of the underlying dynamics.
 

Bullish outlook strategies:

  • Long call (defined risk)
  • Poor man's covered call (defined risk)
  • Short put (undefined risk)
  • Covered call (defined risk)
  • Long call vertical spread (defined risk)
  • Short put broken wing butterfly (defined risk)
  • ...

Neutral outlook strategies:

  • Short strangle (undefined risk)
  • Short straddle (undefined risk)
  • Short iron condor (defined risk)
  • Short dynamic width iron condor (defined risk)
  • Short iron fly (defined risk)
  • ...

Bearish outlook strategies:

  • Long put (defined risk)
  • Short call (undefined risk)
  • Short call vertical spread (defined risk)
  • Long put vertical spread (defined risk)
  • Short protective collar (defined risk)
  • ...
The above lists only show a selection of what is possible. Below I'll post 3 strategies of the above strategies, illustrating how one could enter such a trade. These screenshots have been taken 1 day in advance of the actual earnings and serve only as a guide as how it could be and definitely should not to be copied.
 
Important note: the strategies and examples provided in this article are purely for educational purposes. They are intended to assist in shaping your thought process and should not be replicated or implemented without careful consideration. Every investor or trader must conduct their own due diligence and take into account their unique financial situation, risk tolerance, and investment objectives before making any decisions. Remember, investing in the stock market carries risk, and it's crucial to make informed decisions.
 

1. Bullish outlook example: short put broken wing butterfly

You're looking at a Put Broken Wing Butterfly strategy with a setup for the October 20th, 2023 expiry.

1. Strategy: The Put Broken Wing Butterfly involves buying one in-the-money (ITM) put, selling two at-the-money (ATM) puts, and buying one out-of-the-money (OTM) put. This strategy is used when a trader believes the underlying security will remain within a certain price range until expiration, and is looking to profit from the premium decay.

As described above a broken wing butterfly has normally it's short legs (the sold puts in this case) ATM. In this case we'll put the short legs (the sold puts) a bit lower of the current/last traded price. This will give us some sort of a cushion if our bullish view is invalidated (beware, due to the nature of a butterfly, the aforementioned cushion only works when very near of expiry date). So, as long as we stay above 393.70, we're safe.

2. Trade Setup: The specific trade here involves:
    - Buying one put with a strike price of 405.
    - Selling two puts with a strike price of 400.
    - Buying one put with a strike price of 390.

3. Premium and Risk: The net premium for this setup is $1.30 per share, giving you a credit of $130. The maximum risk for this trade is $370, which will occur if the NVDA moves significantly beyond the 390 strike price at expiration. On the other hand, the maximum profit potential is $630, which will be realized if NVDA is at the short strike ($400) at expiration.

4. Breakeven Point: The breakeven point is 393.70, indicating that as long as NVDA is above this level at expiration, the trade will at least break even.

5. Implied Volatility (IV) Rank: The IV Rank is 97.06%. This can be interpreted as the current level of implied volatility is higher than approximately 97% of its readings over the past 52 weeks.

6. Days to Expiration (DTE): The time until expiration for these options is 59 days.

The  goal of this strategy is to collect the premium, while the underlying (NVDA) continues to move upward. As we collect $130,- on a €108.16 (= +/- $117) margin requirement over a period of 59 days, this yields us approx. 111% return in 59 days or an annualized return of around 677%.

In case the price of Nvidia goes south and opposite of what we expect it will first pass the "cushion" area (the area where we sold our puts), where it will yield it's maximum result at expiration. If it goes beyond that (= below the breakeven point) our strategy will result in loss. Depending on the time where we are we can exit early and limit our losses. If you do nothing and the price goes below the 390 long put, this strategy will result in the maximum loss.
 

2. Neutral outlook example: short iron condor (defined risk)

The second strategy we'll be looking at is the Iron Condor. An Iron Condor is an advanced options trading strategy that is designed to generate a consistent return with a high probability of success, when the expectation is that a stock or index will have lower volatility at/near expiration. The strategy involves four different contracts with the same expiration date but different strike prices.

Here's how it works:

1. Sell an out-of-the-money (OTM) Put: This is a short Put at a strike price below the current price of the underlying asset. You receive a premium for selling this Put.

2. Buy an OTM Put at an even lower strike price: This long put serves as protection in case the price of the underlying asset drops significantly. You pay a premium for buying this put, but less than what you received for selling the first put. The difference between the strike prices of these two puts forms the put spread.

3. Sell an OTM call: This is a short call at a strike price above the current price of the underlying asset. You receive a premium for selling this call.

4. Buy an OTM call at an even higher strike price: This long call serves as protection in case the price of the underlying asset rises significantly. You pay a premium for buying this call, but less than what you received for selling the first call. The difference between the strike prices of these two calls forms the call spread.

So, an Iron Condor consists of two vertical spreads: a put spread (for downside protection) and a call spread (for upside protection), both for the same underlying asset and with the same expiration date.

The maximum profit for an Iron Condor is the total premium received for selling the call and put spreads (minus commissions). This occurs if the price of the underlying asset is between the strike prices of the short call and short put at expiration.

The maximum risk or loss is the difference between the strike prices of either the calls or the puts (they should be the same) minus the net premium received.

Iron Condor trades are a good way to generate income in a non-volatile market, but they also require careful management due to the potential for significant losses if the price of the underlying asset moves too much in either direction.

Now let's have a look at an actual setup:
1. Trade Setup: The setup involves four options on the NVDA-stock:
   - Buying an out-of-the-money 570 Call (expiring 20-Oct-2023)
   - Selling an out-of-the-money 530 Call (expiring 20-Oct-2023)
   - Selling an out-of-the-money 400 Put (expiring 20-Oct-2023)
   - Buying an out-of-the-money 360 Put (expiring 20-Oct-2023)

2. Premium and Risk: The net premium received from establishing this trade is $1670. The maximum risk, or the most you could lose on this trade, is $2330. This maximum loss occurs if the price of NVDA at expiration is either above 546.70 or below 383.30.

4. Breakeven Point: The breakeven points are 383.30 and 546.70. Any price of the NVDA at expiration between these two points will result in a profit from the trade.

5. Probability of Profit (POP): The Probability of Profit (POP) is 43.75%. This is a rough estimate of the chance that the trade will be profitable at expiration. Please note that this is a simplification and actual probability may vary based on factors like changes in implied volatility or the price of the underlying asset. The POP is based on the delta.

6. Implied Volatility (IV) Rank: The IV Rank is 97.06% (which is almost the max of 100%)

7. Days to Expiration (DTE): The options involved in this trade are set to expire in 59 days. This is the period within which the expected price stability should occur for the trade to be profitable.

8. Expected Move: $86, based on a ATM straddle with expiration on 20 October 2023.
 

3. Bearish outlook example: short protective collar (defined risk)

Traditional Protective Collar:
A traditional protective collar is an options strategy that is used by an investor who wants to hedge against a potential downside risk on a stock that they own. It consists of:

    - Selling (writing) an out-of-the-money (OTM) call option: This limits the potential upside gains but generates premium income.
    - Buying an OTM put option: This insures against a significant downward price move in the underlying stock.
   
Together, these two actions form a "collar" around the stock's price, protecting the investor from substantial losses while limiting potential gains.

Additional Put for Premium Optimization:
In the variation of the strategy where an additional put option is sold, the investor adds another dimension to the traditional collar:

    - Selling another OTM put option (with a lower strike price than the bought put): This generates additional premium income but introduces further risk to the downside.

Risk/Reward Profile: The traditional protective collar limits both upside potential and downside risk.

Ownership Required: Since the strategy involves selling a call option, it's typically used by those who own at least 100 shares of the underlying stock. If the stock's price exceeds the strike price of the sold call, the investor may be obligated to sell their shares at that price.

Impact of Volatility: The addition of the sold put to the traditional collar can be more appealing in higher volatility environments, as it allows the investor to collect more premium.

Now let's have a look at an actual setup:
Strategy: Protective Collar
    1. Trade Setup:
  • Own 100 Shares of Nvidia: This is the underlying position being protected.
  • Sell to Open 1 Call: Expiry 20-Oct-23, Strike 535 (cap on potential upside gains).
  • Buy to Open 1 Put: Expiry 20-Oct-23, Strike 360 (protection against a downside move).
  • Sell to Open 1 Put: Expiry 20-Oct-23, Strike 290 (additional premium, further downside risk).
    2. Premium and Risk:
  • Premium (USD): 1260 (Net premium received).
  • Max Risk: Limited to the difference between the stock's purchase price and the 290 strike, less the premium received. If the price goes above 535, shares will be sold at that price (caps profits to the upside)
  • Max Profit: Limited to the difference between the 535 strike and the stock's purchase price, plus the premium received, minus the call's purchase price.
    3. Breakeven Point: 547.6
    4. Other Key Factors:
  • Probability of Profit (POP): 69.18%
  • Implied Volatility (IV) Rank: 97.06
  • Days to Expiration (DTE): 59
  • Delta Position: -0.4048
  • Theta Position: 0.2
NVidia Options Overview - ©barchart.com
In conclusion, the upcoming Nvidia earnings release presents a myriad of potential outcomes that can deeply influence both the short-term and long-term perspectives on the stock. By understanding the scenarios and aligning strategies accordingly, investors and traders can navigate through this complex landscape with a more informed and nuanced approach.

The options strategies outlined in this article provide a framework for different market outlooks, both bullish and bearish, as well as neutral scenarios. Whether you are an investor seeking to optimize a long-term holding or a trader looking to capitalize on short-term volatility, these strategies offer a variety of ways to align your portfolio with your market view.

With careful planning and strategic thinking, the Nvidia earnings release becomes an opportunity to learn, adapt, and potentially profit from the market's reactions. But remember, the stock market is inherently unpredictable, and all investments carry risk. Make decisions with caution and awareness of the broader context, and consider the long-term implications of your choices. Happy trading!
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