The market appears to be too confident in Nvidia heading into its earnings report this week, and that could result in a wider market sell-off, according to Bank of America. Derivatives strategy analyst Gonzalo Asis said in a Sunday note to clients that investors should consider using a defensive options trade to guard against a disappointing earnings report that triggers a sell-off. "NVDA results have been a key driver of equity indices .
.. and investors may be underpricing the risk of a disappointment.
We think S & P put spreads offer better protection than NVDA-based hedges against this risk and its impact on the broader market," the note said. Asis identified a put spread on the SPDR S & P 500 ETF Trust (SPY) as a smart way to position for this potential result. Nvidia is the second-largest holding in the SPY, at more than 6% of the fund, and has become a key sentiment indicator for the broader market during its dramatic rally.
A put option gives the holder the right to sell the underlying asset at the preset strike price. The put spread trade identified by Asis would involve buying the $555 strike put, and selling the $545 strike put. By owning the $555 strike put, the trade is effectively a bet that SPY will fall below that level.
Selling the $545 put helps to lower the upfront cost of the trade, but it does limit the total upside if the market has a major sell-off that results in both options being exercised. SPY 5D mountain The SPY closed at about $562 per share on Fri.