Shares of Nvidia (NASADAQ:NVDA) finally found their footing after a dramatic drop. NVDA stock fell nearly 14% after making new all-time highs at $208.75. Certainly some of the pullback was warranted given that the previous rally had gotten overdone and overheated. The selling has now taken NVDA down too far, too fast. This is especially true given the stock split. Any further weakness would make buying NVDA stock a good opportunity.
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Nvidia split the stock 4:1 on July 20. While a stock split has no real economic benefit long-term from a investing perspective, stock splits usually have a short-term bullish effect on the stock price. It is even more powerful given that the split will be a 4:1 split rather than the usual 2:1 stock split. This will make NVDA stock much more affordable for the smaller investor.
Technical Take On NVDA Stock
NVDA has turned higher after reaching oversold levels. Nine-day Relative Strength Index (RSI) hit the 30 area before bouncing sharply. Moving Average Convergence Divergence (MACD) reached the lowest levels of the past year but has firmed. Momentum also fell to recent lows before turning higher. NVDA stock is trading at a discount to the 20-day moving average as well. The last two times these indicators aligned in a similar fashion signaled significant short term lows in the stock.
Source: The thinkorswim® platform from TD Ameritrade
More importantly, NVDA stock had a key reversal day last Friday. Shares opened lower and near the lows of the day only to reverse course and close sharply higher and near the highs of the day. Plus it was on a day when the NASDAQ 100 dropped over 80 basis points. NVDA was the best performing NASDAQ 100 stock on the day.
This type of price action is a reliable signal that the preceding trend has come to an end. The sellers have become exhausted and the buyers have taken control. It is an even more powerful signal given the magnitude of the recent selling pressure. NVDA stock also held major support at the $175 level, yet another bullish sign.
I am certainly far from a perma-bull on NVDA. I had a decidedly more bearish outlook for NVDA stock in my last research piece on June 25. I noted how both the technicals and fundamentals had reached an extreme and recommended a bear call spread to position for a pullback. Now that the pullback has come to fruition, my bearish outlook has turned somewhat bullish-because price does matter.
Buying NVDA stock outright is both risky and rather expensive, even after the split. Buying just 100 shares would still cost nearly $20,000. Fortunately, the options market provides a lower-cost way to be a buyer on a further leg lower.
The recent drop in both NVDA and the overall market has caused implied volatility (IV) to pop significantly. This means option prices are more expensive, which favors option selling strategies.
Selling an out-of-the money bull put spread makes probabilistic sense. It allows one to position bullishly on an oversold NVDA stock in a defined risk manner. It is so important to lower risk in this type of market environment we are currently experiencing.
How To Trade It
Sell NVDA Aug $172.5/$170 put spread for a $0.35 net credit.
Maximum gain on the trade is $35 per spread. Maximum risk is $215 per spread. Return on risk is 16.27%. The short $175 strike provides a 11% downside cushion to the $195.94 closing price of NVDA stock. It is also well below the support area at $175.
The spread expires before earnings, currently estimated for late August. This eliminates any earnings related risk. It is also a hedge against the bearish call spread I recommended in my previous article on NVDA stock.
On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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