Welcome back to my column with International Business Times.
The US market has displayed unusual bullishness over the past month which baffled many short term technical analysts. Yes, fair enough that the economic data has been extremely bullish lately and that should drive prices higher. However, just as waves come up and down even in a strong rising tide, stocks (and hence the market) pull back slightly due to profit taking after a strong rally no matter how strong the uptrend.
The SP-500 has gained over 14% this past month and once again, a sense of the market being short term overbought lingers in the air. Even as the overbought sentiment rises in the short term, many stocks are displaying enormous earnings recovery and future prospects which makes owning their stocks extremely attractive for the long term. One such stock is Nvidia trading under the symbol of NVDA.
Nvidia should be no stranger to young investors who might already be using their graphics cards in their computers. Nvidia is a leader in visual computing technologies and inventor of the high performance processor known as GPU with PC gamers as their major market. The video gaming industry is an extremely fast growing one with newer generation games challenging the graphics processing limit of every PC. Nvidia announced a much smaller loss last Friday in their earnings release than expected, pushing the stock upwards by 4.5%. Barclays Capital analyst Tim Luke said Nvidia “delievered generally impressive July Quarter F2Q results with solid guidance as revenues and gross margins trend upwards.” Indeed, NVDA’s quarterly results have turned from its lowest in January this year and steadily recovered with analysts expecting positive profit starting next quarter. In fact, Motley Fool is saying that “it’s finally time to buy NVDA”.
So, how do we profit from a stock that is expected to do well over the long term along with the economic recovery but yet hedge against the expected short term pullback in the general market?
This is where using a Married Put is appropriate. The Married Put is like a Protective Put where a put option is bought as a hedge against stocks that you own. The only difference is that a Married put is when the put options are bought at the moment the stocks are bought, marrying the put options to the stock right from the start, while the Protective Put buys put options much later in order to protect profits.
What we could do is to buy NVDA stocks and then buy an equal number of NVDA’s September $12.50 strike price put options. For instance, if you bought 100 shares of NVDA, you would buy 1 contract (representing 100 shares) of September $12.50 put options. This position raises your investment by $0.45 but it ensures that your NVDA shares will not go below $12.50 as you would have the option to sell those NVDA stocks at $12.50 no matter how low it goes!
Is $0.45 a big investment to make for such a protection? Not for a stock that can move $0.50 to $0.70 upwards in a single day! Yes, investing one day’s gain for more than a month of protection under $12.50 makes a lot of sense to me! Since it is a short term pullback that we are expecting, buying the September options instead of longer term ones reduces that cost of “insurance”.
If by September expiration NVDA continues to rally, those put options simply expire worthless like an expired insurance policy with no further action needed from you. There is no need to exercise those options at all! If by September expiration, NVDA dips to lower than $12.50, the put options would completely hedge against all losses below $12.50! If you are confident enough to spot a reversal point and there is still time to September expiration, you could also sell the put options for profit without exercising them and then still hold on to the stocks for the ride up!
Indeed, this is a little money for a lot of flexibility, just like the insurance policies that you buy.
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Disclaimer : Neither I nor Masters 'O' Equity or Optiontradingpedia.com and any of the staff, own any shares in DRYS nor hold the above mentioned options trading position. The above article uses closing prices on 5 June 2009. Actual prices on Monday opening may differ. This article is for education purpose only and should not be taken as individual investment recommendation. Options trading is not suitable for everyone and advise should be sought from your local financial adviser.