Crash Protection Kicks In For Nvidia

|
About: NVIDIA Corporation (NVDA)
by: David Pinsen

Summary

At the end of August, I presented two hedges for Nvidia longs.

Since then, the stock is down about 23%.

Here I show how the hedges reacted to that decline. I also briefly discuss possible courses of action now for hedged longs.

Nvidia booth at Computex, via Bing.

Nvidia Booth at Computex Taipei (credit: Computex Taipei)

Hedging Nvidia At A New High

At the end of August, when shares of Nvidia (NVDA) were hitting a new high, I presented two hedges for the stock. Since then, Nvidia shares are down about 23%, despite their recent bounce.

Chart NVDA Total Return Price data by YCharts

Here, I show how the August hedges ameliorated that slide and briefly discuss courses of action for hedged Nvidia longs now.

The August Optimal Put Hedge

On August 30th, these were the optimal, or least expensive, puts to hedge Nvidia against a greater-than-20% drop by mid-March (optimal hedge screen captures via the Portfolio Armor iPhone app).

Image via PA.

Note that the cost here was $4,750, or 3.42% of position value (calculated conservatively, using the ask price of the puts).

Let's look at how that hedge has reacted to the 23% drop.

How The Optimal Put Hedge Has Reacted

Here's an updated quote on those puts as of Wednesday's close (via CBOE):

How That Hedge Ameliorated Nvidia's Drop

NVDA closed at $277.81 on August 30. A shareholder who owned 500 shares of it and hedged with the puts above then had $138,905 in NVDA shares plus $4,750 in puts, so the net position value was $138,905 + $4,750 = $143,655.

NVDA closed at $213.79 on Wednesday, November 7th, down about 23% from its close on August 30th. The investor's shares were worth $106,895 on Wednesday, and the put options were worth $14,662.50, using the midpoint of the spread. So, the net position value as of Wednesday's close was $106,895 + $14,662.50 = $121,557.50. $121,557.50 represents a 15.4% drop from $143,655.

The August Optimal Collar Hedge

On August 30th, this was the optimal collar to protect against a >20% drop in NVDA by mid-March, while not capping your possible upside at less than 20% by then.

Image via PA. In this case, the net cost of the hedge was negative, meaning you would have collected a $325 net credit, assuming, conservatively, that you bought the puts and sold the calls at the worst ends of their respective spreads.

How That Optimal Collar Hedge Has Reacted

Here's an update quote on the put leg of the collar (note that it's at a different strike than the first hedge):

And, here's an updated quote on the call leg:

How That Hedge Ameliorated Nvidia's Drop

Recall that NVDA closed at $277.81 on August 30. A shareholder who owned 500 shares of it and hedged with the collar above then had $138,905 in NVDA shares plus $3,675 in puts, and if the investor wanted to buy-to-close the short call position, it would have cost him $4,000. So, his net position value on August 30th was ($138,905 + $3,675) - $4,000 = $138,580.

On Wednesday, the shares were worth $106,895, the put options were worth $13,175, and it would have cost $425 to buy-to-close his calls, using the midpoint of the spread in both cases. So: ($106,895 + $13,175) - $425 = $119,645. $119,645 represents a 13.7% drop from $138,580.

A Bit More Protection Than Promised In Both Cases

Although Nvidia had dropped by about 23% from August 30th to November 7th, and both hedges were only designed to protect against a >20% drop, the optimal put hedged position was only down 15.4%, and the optimal collar hedged position was down 13.7%. In both cases, the time value of the put options gave a bit more protection than promised since the hedges were structured to protect based on intrinsic value alone.

What Now?

That depends on what you think Nvidia's prospects are between now and March. Seeking Alpha contributor Julian Lin made his case for why he's a long-term bull on the stock last week, but I'm not sure what his view on it is over the time frame of the hedges above. Seeking Alpha contributor ATL Perspective, in contrast, saw headwinds on the horizon. The nice thing about being hedged, though, is that it gives you options (no pun intended). You don't have to worry so much about how much further Nvidia might drop because your downside is strictly limited. You can exit now, for a smaller loss, you can buy-to-close the call leg of your collar to remove your upside cap, if you're bullish, and if you're even more bullish, you can sell your appreciated puts and buy more Nvidia shares. In any case, you have breathing space to let the dust settle and decide on your best course of action, without the anxiety of an unhedged investor.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.