On the surface, semiconductor giant Nvidia (NVDA) finally looks like an appetizing proposition. Since the start of the year, NVDA stock has slipped more than 11%, an obvious consequence of the cracks in artificial intelligence along with the war in Iran. In fact, circumstances have become so shaky for the tech juggernaut that NVDA has ignominiously been rated as a 72% Strong Sell.
Of course, many folks who have been eager to buy Nvidia stock at a more reasonable valuation are greeting the volatility with open arms. Per Reuters, NVDA’s price-earnings ratio has recently sunk to a seven-year low amid the latest chaos.
Looking strictly at the numbers, it’s easy to be tempted by the implied proposition. Right now, NVDA stock trades at a forward earnings multiple of just under 21; this figure was nearly 40 at the end of July last year. From that perspective, it’s a red-hot deal. So, why isn’t the smart money jumping on board?
If you look at the most recent options flow data, net trade sentiment fell to $265.3 million below parity. That’s a sizable plunge, considering that total gross bearish volume was just under $284 million below the zero line. Yes, it’s true that options flow often fluctuates wildly from day to day considering its episodic nature. However, volatility skew — which tends to be more structural — also leans toward skepticism.
To answer the question about the hesitancy of smart money traders, we need to realize that securities like NVDA stock represent non-stationary processes. As such, when the price of NVDA falls, it’s not guaranteed that it’s a discount. Rather, it could be a discount — but that’s something that needs to be figured out.
Volatility Skew Provides an Early Detection Radar for NVDA Stock
Fundamentally, the reason why a stock on a downswing doesn’t necessarily equate to a discounted opportunity comes down to the stationarity of utility or lack thereof. Especially in this day and age, off-price department stores are super popular because you can find legit brand-name goods for deep discounts.
The same philosophy should apply to NVDA stock, right? Well, not quite.
When you buy a frying pan from an off-price retailer, the utility of the pan doesn’t change from season to season. However, the same cannot be said about NVDA stock. During the pre-AI bubble, pre-Iran state, the security exchanged hands for over $200. In the post-bubble, post-Iran state, the market has deemed the risk profile to be acceptable at around $165.
Let’s say we have a ground invasion of Iran. In that horrific state, NVDA stock may only be an acceptable risk at below $150. Based on past analogs of prior shock events, it’s not out of the question for the tech giant to fall to roughly $140.
Obviously, it’s impossible to say with absolute certainty where NVDA stock will ultimately land. But that’s also why the volatility skew is such a useful indicator. In essence, the skew represents the insurance that smart money traders are willing to pay to protect themselves against unexpected price swings.
What we’re seeing with NVDA stock is generally a calm skew. However, the structure of the skew — which shows rising insurance demand for tail risk — implies that sophisticated market participants are more concerned about a downturn than they are about capturing upside. Relatively speaking, the smart money has not positioned itself to capture upside convexity.
Bottom line, we’re looking at a skew that is defensive in nature. Does this guarantee that NVDA stock will fall from here? No, the smart money isn’t prescient. However, when the top players are consistently buying downside protection, that should tell you something.
It’s Good to be Bullish but Patient
If you’re looking further down the road, Nvidia stock does seem to be an attractive proposition. My feeling right now is that, at some point, a debit spread will look intriguing. At the same time, I’m concerned about sustained volatility.
Because the smart money isn’t biting yet, I’m not exactly eager to pull the trigger just now. If you want my opinion, NVDA stock may have a bit more to fall before it becomes a compelling buy.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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