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 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 pre-set 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 up-front cost of the trade, but it does limit the total upside if the 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 Friday. The index-tracking ETF closed at $562.13 per share on Friday, meaning that the first put option would already be “in the money” if the SPY fell just 1.4%. That’s less than half of the 2.9% decline for the fund on Aug. 5, a day which also saw the Cboe Volatility Index (VIX) spike to its highest level since 2020. “The VIX 65 episode of 5-Aug highlights the return of fragility for the broader equity market … and the S & P has often remained fragile after such events,” the note said. Nvidia is set to report its earnings on Wednesday. Bank of America recommended the put spread that expires Sept. 6, which would also cover the jobs report and other economic indicators that come out in the first week of September.
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