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NVIDIA Long Iron Condor

DISCLAIMER:

This association and its publications are solely intended for academic purposes and should not be used as investment advice or be interpreted as such.


(NASDAQ: NVDA)

Source: Interactive Brokers , Trade Workstation

Play: Long Iron Condor Spread

Maturity: 16th February 2021


Company Presentation

Introduction

Nvidia Corporation is one of the leading companies operating in the Computer Hardware industry alongside IBM, Intel and AMD. The company focuses on PC graphics, graphics processing units (GPUs) and AI, but extends to other markets such as AI for self-driving cars. Nvidia is a pioneer in the GPU sector inventing the first GPU in 1999, hence simultaneously redefining computer graphics and sparking growth in the gaming sector which has ever since been rising. It holds 18% of market share of the GPU sector vis a vis Intel dominating at 63% and AMD being a close competitor at 19%. Its market cap is valued at 325,4b. Nvidia’s GPU brand caters to specialized markets among those being GeForce for gamers, DGX and Tesla for AI and big data scientists as well as GRID for cloud-based visual computing users. Its Tegra brand is an innovator in the gaming and entertainment devices by creating a single chip that combines both GPUs and CPUs (multi-core central processing units) that are focal points in the autonomous vehicle and drone sector. Furthermore, the company has diversified its offerings to its buyers by developing platforms catering to them like the NVIDIA DRIVE AI supercomputer. Nvidia's Drive PX platform is a deep learning tool for self-driving that is being used in R&D at more than 370 partners worldwide.

Nvidia benefits especially from the growing popularity of gaming as it is the leading supplier of gaming specialized GPUs. The number of PC gamers has risen by 30% in the past 4 years. Gamers are forced to upgrade GPUs to play newly released videogames that need processors x5 faster than those released in 2014. Another factor fuelling its growing revenues would be the general growth of the GPU market which is projected to quadruple to 80b in 2024 from 17b in 2017.

Its Trailing PE stands at a high 85.54. However, the company has a promising Forward PE signalling higher EPS and growth in revenue generation.

Acquisitions:

Nvidia is currently expanding through horizontal integration. Earlier this year, the company announced its acquisition of ARM from Softbank for 40b. Mellanox, another company acquired by Nvidia, widened their knowledge on soft chip expertise. Should the acquisition of ARM close successfully, Nvidia would reap revenue synergies if it succeeds in building a server CPU using ARM’s architecture which is present in effectively all smartphones and its customer base. De facto, ARM exhibits a strong architecture, but this has proven to be risky with Broadcom and QUALCOMM both failing at the same task. Nvidia is likely to integrate its GPU and AI IP in ARM’s extensive IP base and licence it to its customer base. Revenue is projected to grow at a rate of 20.5% compound annual growth rate until 2025. This year has proven to be difficult for the company, with gaming revenue falling due to cryptocurrency-mining related hangover and stalling inventory channels. Regardless, fiscal 2021 is anticipated to grow by 50% thanks to the acquisition of Mellanox.


Market presence:

As we’ve detailed previously, Nvidia is present in different markets, namely: GPUs, SoCs, AI, Data Centre, Self-Driving vehicles. Nvidia's management team has shown a willingness to invest in new opportunities in the past several years outside the firm's core PC graphics processor business. As a result, Nvidia has become a key player in the artificial intelligence accelerator market as well with its GPUs for AI training and inference workloads. However, its main business is Graphical Processing Units (GPUs), in direct competition with AMD and Intel.


The Graphical Processing Units Market has been growing extremely fast in the last few years and is expected to grow more in the future. In 2017, the GPU market size was estimated at 12 billion USD, while in 2019 the value grew to 19.75 billion USD, amounting to a CAGR (Compound annual growth rate) of 28.29% until 2025. However, the expected future growth of this market is even larger. Indeed, according to a recent report by Allied Market research, the CAGR from 2020 to 2027 will be at around 33,6%. According to a report by Global Market Insights, the GPUs market’s CAGR between 2018 and 2024 will result at 30%, and lastly, according to a report by Mordor Intelligence, the CAGR in the period between 2019 and 2025 will be 31.1%.


The PC market is maturing, as analysed by Morningstar. The GPUs growth is mainly due to growing enthusiasm in the Gaming sector, since the GPUs are ideal to enhance the performance of PCs for Gaming. The Coronavirus pandemic has compromised assembly and distribution lines and has not been able to match demand with their newly announced gaming GPU. However, this only increased the excitement around it and bodes well for the future.


Fundamental analysis

The P/E ratio of the Nvidia stock is very high indicating an expensive stock price. Among its peer group of semiconductor companies, this is also above average. However, this is based on exceptional growth expectations which can be backed with historic data. Recent quarterly sales growth in Q3-2020 amounts to approx. 57% YOY. Profitability in terms of operating margin and return on assets is far higher than its peers. The financing of Nvidia is very healthy considering the low indebtedness. Annual dividend per share recently amounts to 0.64$ resulting in a dividend yield of approx. 0.1%. This is far below S&P 500 as well as industry average. However, given a pay-out ratio of approximately 10%, there is room for further growth.


Technical Analysis

Looking at the Fibonacci pivot points (Figure [3]) for the next month, it will likely fall beyond the price of $504.75 or rise above $574.93 as they are the nearest support and resistance line. From using these points, we can safely assume that the price will reach either price by the end of the month, this further motivates our strategy (see bellow)

The 14-day Average True Ratio indicates that the stock is highly volatile. The ATR is calculated by finding the average distance between each month's high and low prices, which indicates that in average there is a big price change each month. In addition, the bottom of Figure [4] shows that the Relative Strength Index, the Stochastic oscillator, and the Williams %R all have gone red in the past few months but there has been no major pullback in price. Therefore, these indicators consider the stock to be overbought which could imply a sell off for many investors. However, other investors consider it a strong buy because of the positive moving averages and massive increase in price over this year.


This final part of the technical analysis further motivates our view. The stock has rallied all year and recently stabilized, but the Bollinger bands have tightened considerably very recently indicating a potential strong move (up or down) soon- earnings could be a catalyst. As noticed before, the direction is difficult to predict with trend-less short term metrics. Hence, we have chosen to take a directionless trade that requires a strong move in one of the possible directions.


Seasonality Analysis

The stock market has a tendency to perform well at the beginning of the year because at this time people tend to have more capital, and they rebalance their portfolio for the upcoming year. We have seen throughout the Coronavirus pandemic that the rise in the number of retail investors has led to more volatile prices. During the holiday season, when people seem to have time at home, they will be more likely to buy shares and push up prices. Moreover, January is always an interesting time of the year because people start “rebalancing” their portfolio. NVDA will be a stock worth watching over this period because people might believe it has started to cement itself as a tech giant, and others will say that it is overbought, and investors might start selling their positions to cash-in profits. Many investors will make up their minds on NVDA at the end of this year, which will result in great price movement at the beginning of 2021.

The Play

The current price of NVIDIA is $520.53.

We propose a Long Iron Condor Spread play ending on 16th of February:

The whole cost of this operation is $21.54 with a maximum profit of $4.48, implying a return of 20.81%. The risk of this strategy is that it does not make any money if the price does not change more than ±3%. However, if the price movement is greater than ±3% then it earns some money and breaks-even at ±7.13% (<483.41or >557.64). Finally, if the price changes by ±8% the strategy reaches its profit maximizing point. We chose this strategy rather than doing a straddle because: there is less risk involved because you are financing the options bought with the options you sold, and because this strategy breaks-even at a closer price.

The 16th of February was chosen as the maturity date because it is a day before the release of Q4 earnings. We expect there to be a market correction at this date and, therefore, advice closing the position before their earnings are released. For more specific information on pricing and the specific of each option please refer to Appendix A.

Overall, we find this play attractive because of the limited risk (difference in premiums) and also because of the volatile market. We are confident there will be a price swing of at least 8% in either direction before the maturity date. If the price swings 8%, the strategy will pay off more (20.81%) than if you would have bought a short or a long of NVD and it protects you from picking the wrong side.


The main risk and drawbacks of this play is the possible risk of early assignment on the short legs. Although there are no dividends distributions before our expiry date and the option's volatility make early assignment less attractive for long investors the possibility is still there. Moreover risk assignment is less dangerous than some other spreads as if assigned, the long positions are available to execute early and won't result in a loss.

Let's see how a possible assignment of the short legs would turn out:

Call: 562.1729 - 536.1459 - 10.08 (net call spread cost, see appendix) = 15.947 profit

Put: 504.9141 - 478.8876 - 11.46 (net put spread cost, see appendix) = 14.5665 profit

possible assignment would not lead into losses which limits potential risk even more, although if assigned you may need to close your position as it no longer is hedged against all directions but rather speculative in a certain direction.

It's also important to notice that getting assigned will require large funds and therefore a strong margin account is recommended (just in case) as each assignment will originally set you back -100 or +100 shared of NVIDIA which is over $50,000 (all for a $20 spread) before you eliminate that position at a profit by executing early your counterpart long position.


*Disclaimer: Profits are calculated as if, we wait until the maturity date and the price falls in the specified range for each case. If we want to close any of the plays before the maturity, we will have different pricings than the ones specified.


Motivation and Recap

Whether you believe in the continuing growth of Nvidia or not, there is no denying it is a very fascinating stock in a competitive and innovative industry.

Nvidia is well positioned in a growing industry, as well as debuting in others (such as self-driving car software), casting even more excitement on its development.

Indeed, we have found Nvidia to have a high levels of volatility using the ATR (14), and opinions differ on its fair value. Most data-based analysis point to Nvidia as being overvalued or overbought, however, the same was being said about Tesla months ago, and the stock has soared.


Nvidia has potential to be an extremely polarizing stock at the end of the year. People can have two views on this company, some investors could say that Nvidia is overbought because it is selling at a 87x PE ratio and look to capitalize on their earnings from an increase in price of 121% YTD. While others look to buy Nvidia and see it as very competitive in the tech world and will buy the stock in the new year as they rebalance their portfolio with fear of missing out on another sharp price increase. The technical and seasonality analysis points at a volatile time for this specific company, as people have been uncertain for the last couple of months and investors will make their decision by the start of 2021.

Whether Nvidia’s stock price will increase or decrease is hard to predict, since there are many factors that may cause price swings. Indeed, the recent acquisition of Mellanox (that is yet to reveal its results), the impending acquisition of ARM, as well as other events will surely affect NVIDIA’s stock price at the start of 2021. Therefore, instead of betting on a particular direction in the stock’s price movement, we decided to venture on high volatility. Our strategy entails a long iron condor spread. The cost of the strategy totals $21.54 and our maximum profit is capped at $4.48 which yields 20.81% in two months on our investment. It is set to mature on February 16th prior to the release of Q4 financials.


APPENDIX

Appendix A: Specific pricing of the strategy with maturity date 16/02/2020.