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Nervous About Your NVDA Gains? A Solution to Both Protect and Participate with No Cash Outlay

NVDA has been one of the biggest beneficiaries of the recent AI craze, as the company has added 90% to its market capitalization year-to-date and a staggering 251% year-over-year. It’s now the third-largest company in the world with a market cap of about $2.4T, trailing only AAPL ($2.6T) and MSFT ($3.2T). If you or a client have been fortunate enough to ride this rally, you’re likely very pleased by the recent performance but also potentially have excess exposure to shares of this single, volatile company. As we’ve discussed in previous blogs, companies with the highest market capitalization have historically underperformed broad-market indices over longer timeframes. 1https://exceedinvestments.com/where-are-those-top-10-companies-now-nineties-focus/ 2https://exceedinvestments.com/where-are-those-top-10-companies-now-millennium-focus/ 3https://exceedinvestments.com/where-are-those-top-10-companies-now-2010-focus/ This isn’t to say that NVDA is going to underperform the broad market going forward, but history has shown that the upside outliers are scarce.

As a shareholder of a now-concentrated NVDA position, an investor faces the tradeoff of holding a portfolio with elevated embedded volatility that is exposed to greater downside risk versus selling a portion of their NVDA holding to diversify into a balanced market portfolio. However, rebalancing out of a highly-appreciated stock will likely come at the cost of a big tax bill. Thankfully, there is a solution using options that allows investors to hedge downside risk while also participating in significant potential share appreciation, and greatly reducing volatility while deferring and seeking to minimize capital gains taxes.

A collar is an option overlay strategy that involves selling an upside call against an existing stock position and using the proceeds from that sale to purchase protective puts that limit downside to a predefined level. A “zero-cost collar” is one of the more popular option strategies and involves matching the premium collected from the sale of the call to the cost of purchasing puts, thus requiring no or very little cash outlay, inclusive of the cost of executing the trade. There is an implicit cost of potential foregone upside in the event the stock rallies above the sold call option strike, but collars can even be structured as a net credit to the investor if so desired, resulting in a cash inflow.

 

 

Option prices are dynamic and are partially driven by demand for bullish exposure (calls) versus bearish exposure (puts). When stocks rally sharply, calls are generally more “expensive” relative to puts because of excess investor demand to buy those calls and place bullish bets on continued appreciation. Contrarily when stocks sell off sharply, investor sentiment can shift dramatically and drive excess demand for put options. This is known as skew and is a common metric followed closely by option traders. The recent sharp rally in NVDA has driven call prices significantly higher than puts, creating the potential to use a collar overlay on an NVDA stock position very efficiently. At this point in time, you can sell very “expensive” calls and buy relatively “cheap” put options, maximizing the tradeoff between potential upside appreciation and downside protection via option collars. The chart below depicts the difference in implied volatility of calls versus puts, with the difference in implied volatility of 25-delta (out of the money) options plotted on the Y-axis. When the reading is positive, puts are relatively more expensive than calls, and when the reading is negative calls are more expensive than puts. The put-call skew reading hit an extreme low a couple weeks back, indicating that calls were at their most expensive level relative to puts at any point over the past three years. While this extremely low reading has reverted somewhat higher since then, the current level remains well below long-term averages.

 

 

NVDA closed at 925.61 on 3/26, and the options market has a volatility expectation of +/- 43.4% for NVDA shares between now and June 20, 2025, 450 days from today.4Using the midpoint of 6/20/25 option prices as of the market close on 3/26/24 for an at-the-money straddle This means that the options market is currently pricing NVDA to close within a range either 43.4% higher or lower from here, or between about 524 and 1327 by 6/20/25. Options can often be wrong about the realized volatility over a period, but we like to use this as a baseline expectation of outcomes over a certain timeframe to give a general idea how to best structure these trades.

Assuming the options market is correct about its volatility expectation, you can currently sell the 6/20/25 1340-strike call on NVDA for about $110 per contract and buy the 790-strike put for about the same price. What this means is that a holder of an NVDA stock position with this collar overlay can fully participate in 44.8% share upside between now and 6/20/25, while limiting downside risk to a maximum of 14.7%. Perhaps the investor would like a little more upside potential and less downside protection or vice versa – below is a list of currently available collars that can be implemented at close to zero cash outlay. These strategies are fully customizable, so the NVDA holder can choose exactly how much potential upside or downside protection they desire and structure the trade accordingly. As you can see, the potential upside is generally a multiple of maximum downside by about a factor of 3 – this is a result of the excessive skew in NVDA call options that currently exists.

 

 

Options trading is nuanced and complex, with the opportunities that exist largely a product of the market environment. Recent trends in NVDA options have created what we view as a compelling opportunity for an investor currently sitting on a concentrated NVDA position. This collar overlay will significantly reduce volatility, allow the holder to still participate in some level of potential appreciation, and defer having to rebalance the portfolio and pay capital gains taxes. Contact us for a consultation as to how you can use the recent developments in the NVDA options market to your advantage.

 

 

 

 

 

IMPORTANT DISCLOSURE: The information in this blog is intended to be educational and does not constitute investment advice. Exceed Advisory offers investment advice only after entering into an advisory agreement and only after obtaining detailed information about the client’s individual needs and objectives. No strategy can prevent all losses or guarantee positive returns. Options trading involves risk and does not guarantee any specific return or provide a guarantee against loss. Clients must be approved for options trading at the custodian holding their assets, and not all retirement accounts are permitted to trade options. Transaction costs and advisory fees apply to all solutions implemented through Exceed and will reduce returns.

 

Top 3 Ways to Incorporate Options Into Your Practice

Options are broadly misunderstood and underutilized as tools in many wealth management practices. Most retail investors and even many advisors have an immediate negative reaction to just hearing the word “Options.”  Many investors simply think of the options market as a personal casino with the potential to win and lose fortunes. We’ve all heard horror stories about a friend or colleague who took a big risk on an option position and lost it all – but it is so much more than that.  What many fail to realize is that options are extremely flexible instruments that can be used to create an income stream, dampen volatility, and even reduce or eliminate capital gains tax liability.  When used properly, options can provide significant benefits to wealth managers and their clients.

Equity markets have struggled for the past year and a half as inflation concerns, geopolitical issues, and recession fears continue to dominate the headlines. This environment has many investors looking for new ways to produce returns. One method to generate diversified yield is to sell covered calls against core stock holdings. Someone who writes (sells) calls against their stock position is limiting their upside over a specified timeframe but receives payment in the form of option premium for doing so.  Practitioners of this strategy will generally sell calls at or above a price level that they deem unlikely to be seen over the life of the option. This allows the stockholder to still participate in share price appreciation, while also generating an income stream and lowering volatility.

Options are widely used by institutional investors for hedging their exposure but are largely overlooked by financial advisors and retail investors for that same purpose. While hedging may be unsuitable for some investors, it can make a lot of sense for those who have reduced risk tolerance. If an advisor has a client concerned about a specific position or the market in general, a simple hedge using options can be used to de-risk the position and help everyone rest easy at night.  Using options offers a great deal of flexibility as to how the hedge can be structured, and oftentimes this can be done at little or no cost with collars. These strategies aren’t for everyone. There are transaction costs involved—which are often higher for options than for other securities. Similarly, hedging trades can erode profits on positions that continue to appreciate, and the option contract itself is a wasting asset.

Arguably the most valuable yet least used application of options is for tax optimization within a portfolio. Many buy-and-hold investors find themselves in the position of being heavily exposed to one or a few companies. Assume a hypothetical investor purchased a sizeable position in a stock like AAPL, NFLX, or MSFT many years ago and has never rebalanced their portfolio to avoid paying capital gains taxes. These holdings are likely now a large percentage of their investable wealth and create the potential for excess volatility and large losses. Option overlays can be used to combat this concentrated stock risk and potentially eliminate capital gains tax liability over time. These strategies can be structured to meet the exact goals of each client without being a drain on liquidity.

Options offer a wide variety of benefits to an advisory practice but are generally overlooked because of their complexity and attention required. In addition to this, there are a very specific set of rules that must be followed to realize their potential tax benefit. The team at Exceed Advisory has over 40 years of professional derivatives experience and can help simplify this process and add value for your clients.

 

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IMPORTANT DISCLOSURE: The information in this blog is intended to be educational and does not constitute investment advice. Exceed Advisory offers investment advice only after entering into an advisory agreement and only after obtaining detailed information about the client’s individual needs and objectives. Hedging does not prevent all losses or guarantee positive returns. Transaction costs and advisory fees apply to all solutions implemented through Exceed.

You Made a Fortune in One Investment. Now What?

The Pareto Principle states that roughly 80% of consequences come from 20% of the inputs. This concept was developed by economist Vilfredo Pareto in the 1800s and has multiple applications in business, including management, marketing strategy, customer service, and investing. In the finance world, application of this principle lends itself to the theory that the vast majority of an investor’s gains come from a small percentage of their total investments, while most of their portfolio will underperform the broad market over long time horizons.

Many investors find themselves in the enviable predicament of having too much exposure to one or a few companies because of their outperformance versus the market. A theoretical buy-and-hold investor who bought a big position in Apple (AAPL) 10+ years ago would be a good example of this. Yes, the rest of their portfolio has likely appreciated over that timeframe, but AAPL has far outpaced the market. As a result, a large portion of this person’s wealth is now tied to one company. Other examples of this phenomenon include employees of a company who have accumulated significant wealth via stock options and others who have inherited sizeable stock positions. Holding such positions dramatically increases risk and leaves them vulnerable to significant drawdowns. Numerous studies have shown that portfolios with concentrated positions are destined to underperform – it’s only a matter of time. 1Baird’s Private Wealth Management Research, “The Hidden Cost of Holding a Concentrated Position. Why diversification can help to protect wealth.” https://www.bairdwealth.com/siteassets/pdfs/hidden-cost-holding-concentrated-position.pdf 2Nathan Sosner, “When Fortune Doesn’t Favor the Bold. Perils of Volatility for Wealth Growth and Preservation. ”The Journal of Wealth Management Winter 2022, jwm.2022.1.189; DOI: https://doi.org/10.3905/jwm.2022.1.189

Someone looking to rebalance into a diversified market portfolio has to make the important choice of how to reallocate their funds. There are generally four options: 1) Sell the shares and take a big hit to the portfolio value via capital gains taxes, 2) Use traditional tax-loss harvesting methods and sell some losing positions to offset the gains in their concentrated position, 3) Transfer their position into an exchange fund, or 4) Use option overlays to mitigate or eliminate tax liability. Let’s take a look at each of these methods.

An outright sale of the shares is by far the most punitive of the above choices. Federal long-term capital gains tax rates in 2023 are 15% for married couples earning over $83k per year and reach 20% for those earning more than $553k annually. Additionally, 42 of 50 states tax capital gains as income and the tax rates range from 2.9% to 13.3%, with most landing in the mid-single digits.  Selling the shares outright can be viewed as an immediate loss of 15-25% of that position’s value, and the tax bill can be significant in many situations. Limiting such liabilities is obviously optimal for long-term wealth appreciation.

Traditional tax-loss harvesting is a very popular method employed by wealth managers, but it has its shortcomings. Generally applied near the end of the year, advisors will look to rebalance their client portfolios and avoid taxes due by selling both losing and winning positions. If you can accrue losses equal to the amount of gains that have been booked, then the effective tax liability is zero. However, this requires that the client actually has significant paper losses that can be harvested. The end of 2022 was a very popular time for this method because of the large number of companies that experienced significant declines, but loss harvesting won’t always be a viable option. This flies in the face of the traditional methodology of “buy low, sell high,” as you’re selling both losing and winning positions. Lastly, wash sale rules require that the investor can’t buy the position back for 30 days after it’s sold.

Exchange funds have become popular vehicles for tax optimization among ultra-high-net-worth individuals. An investor looking to reduce a concentrated position can move it into an exchange fund, which is basically a pool of other concentrated positions that have been aggregated by an asset manager. The investor is “exchanging” their holding in one or a few positions for a pro-rata allocation of the pool of assets. This diversifies their portfolio, reduces risk, and allows the holder of one or a few stocks to now own a percentage of the fund without having to sell their concentrated holding and pay capital gains taxes. While this may sound like the perfect solution for concentration issues, exchange funds have their problems. Most have a minimum position size of $5M, which effectively eliminates this option for a huge percentage of investors. For those able to meet the minimum asset requirement, entering into an exchange fund requires a seven-year commitment. Any asset sales before the end of this lockup period will result in penalties due to the fund, and in some instances the fund will just transfer the original concentrated position back to the investor. For anyone who may have short-term liquidity needs over the next seven years, this makes such a time commitment a difficult proposition. Lastly, exchange funds can be expensive, with many charging a management fee of 150-200 basis points annually. Despite these shortcomings, exchange funds can still make sense for some individuals who have significant tax liabilities and low liquidity needs.

Option overlays are the final (and in our biased opinion, best) solution for mitigating tax liability and concentration issues. An investor holding a large position in one company can use covered calls or collars as tools to reduce volatility, generate yield, and in many instances completely eliminate tax liability over time. The strategies offer a great deal of flexibility and can be tailored to meet the specific needs of each individual investor. An option overlay program can be either systematic or tactical, which can create the potential for excess alpha generation and isn’t a drain on liquidity. Depending on volume and transaction size, the costs to implement these programs are often minimal when compared to those of an exchange fund. The use of options will require the investor to pay commissions to their broker, and of course there are management fees assessed. However, in many cases, the total cost to the investor may be significantly less than the price of other solutions.  The cost is also usually minimal when compared to the tax savings that can be realized. Most option overlay strategies can be implemented for 50 basis points annually or less, and this cost is oftentimes only a small fraction of the total tax liability.

Options provide a value-add to an advisory practice and its clients, but they can be complex. Additionally, the tax code is difficult to navigate and these overlays will require constant attention and rebalancing. The team at Exceed Investments has over 40 years of professional derivatives experience and can streamline this process for you and your clients, allowing them to efficiently grow their wealth.

Contact us for a consultation.

 

 

This blog post is for informational or educational purposes only and is not intended as investment advice.  Any discussion of investment strategy or approach is intended only to illustrate investment concepts and in no case does the discussion represent Exceed Advisory’s investment performance or the results of any Exceed Advisory portfolio.  We provide investment advice only to clients and only after entering into an advisory agreement and obtaining information concerning individual needs and objectives. We think the information provided is accurate, but accuracy is not guaranteed. All investing in securities involves risks, including the risk of loss.