Options Traders Line Up Hedges Before Pivotal Nvidia Earnings

As Nvidia Corporation (NVDA) prepares to report its third-quarter fiscal 2024 earnings on Wednesday, August 28, options traders are lining up hedges to protect their portfolios from potential market volatility. The chipmaker, known for its dominant position in the AI chip market, is expected to post another quarterly sales record, driven by strong demand for its advanced chips. However, the high implied volatility and significant volatility skew in Nvidia's options leading up to the earnings announcement have traders on edge.

One strategy that traders are employing to capitalize on the current market conditions is the diagonal put spread. This advanced options strategy involves selling a put option with a shorter expiration date and a higher strike price, and buying a put option with a longer expiration date and a lower strike price. By doing so, traders receive a net credit, which means there is no risk on the upside. The maximum potential gain is achieved if Nvidia's stock price closes right at the strike price of the sold put option on the expiration date of the shorter-dated put option.

However, the risk on the trade is on the downside, with a potential maximum loss calculated by taking the difference in the spread multiplied by 100 and subtracting the premium received. The maximum potential loss occurs if Nvidia's stock price drops below the strike price of the bought put option on the expiration date of the longer-dated put option.

One of the advantages of this trade is that the put option being sold has higher volatility than the put option being bought, allowing the trader to sell high and buy low in terms of volatility. Closing the trade before the earnings date of August 28 can help avoid earnings risk.

According to BofA Global Research, Nvidia's earnings have been a consistent driver of short-term stock-market performance since January 2023, with a high correlation between Nvidia's stock reaction to earnings and the S&P 500's performance in the two weeks following the release. Therefore, a disappointment in Nvidia's earnings could have a significant impact on the broader tech sector and the S&P 500. To hedge against these risks, BofA Global Research suggests buying put options on the S&P 500 instead of Nvidia's stock itself, as it is "more attractive" and offers better protection against market-wide fragility and upcoming macro drivers.

In conclusion, options traders are lining up hedges before Nvidia's pivotal earnings announcement, taking advantage of the high implied volatility and significant volatility skew in the company's options. The diagonal put spread strategy is one way to capitalize on the current market conditions, but it also entails risks, such as a potential maximum loss if the stock price drops significantly. Additionally, investors can consider buying put options on the S&P 500 to hedge against the potential impact of Nvidia's earnings on the broader market. As always, it is essential to do your own due diligence and consult with a financial advisor before making any investment decisions.