Wait for this price action in NVDA before buying a breakout

Breakout Pullback Trade Follow-Up

Not always, but when a breakout pulls back, it can give you a great chance to get into a trade at a bargain price. This was the case with our December call backspread on NVIDIA Corporation (NVDA | Quote | Chart | News | PowerRating) back on August 12. You’ll recall we identified a classic breakout from a ‘cup with handle’ formation, and then over the course of several days following the breakout, watched the stock dip back into the handle region, as can be seen in Figure 1.

NVIDIA Corporation (NVDA | Quote | Chart | News | PowerRating), which designs, develops and markets graphics processors software for use in personal computers and digital entertainment platforms, has since that time has rallied from 29.34 up to 34.23 (at the time of this writing), as can be seen in Figure 2.

Figure 1 – Generated Using OptionVue 5 Options Analysis Software

Figure 3 contains the details of the December call backspread at entry and at current prices. As you can see, the December 25 was originally sold for 5.00 ($500) and for the two out of the December 30 calls we paid 2.20 for ($220 each, or $440). This left us with a net credit of $60, which after commissions would be our potential downside profit if we fell low enough, a nice bonus to these types of trades since when these types of breakouts fail, they can drop far.

But since NVDA has risen, the position has produced a profit on the upside of $210, as can be seen in Figure 3. The current spread price has moved from +$60 to -$150, so if we closed this trade, we would show a profit of $210 (based on 9/29/05 settlement prices).

Figure 2 – Generated Using OptionVue 5 Options Analysis Software

This represents a profit of 36.8% on required margin for the trade, which was $640. While there is potential for more upside profit (upside profit potential is unlimited in a call backspread), it might be a good idea to lock in some profit and not let remaining positions show more losses than you have already realized. This way you have a “risk free” position in place for potential win fall gains.

Figure 3 – NVDA December Call backspread current prices are based on settlement 9/29/05.

Next week, I will look at some of the down gapper call spread trades highlighted in previous articles.

Have a great weekend!

John Summa

John F. Summa is Founder and President of OptionsNerd.com, and a registered Commodity Trading Advisor (CTA) with the National Futures Association (NFA). Founded in 1998, OptionsNerd.com offers trading seminars and tutorials to options traders, futures and option trading advisories and managed futures and options CTA account services. Mr Summa's trading articles have appeared in Technical Analysis of Stocks & Commodities magazine, as well as Active Trader Magazine, Options Trader Magazine, Futures Magazine, Stock, Futures & Options Magazine, and Investopedia.com. He coauthored Options on Futures: New Trading Strategies and Options on Futures Workbook (John Wiley & Sons, 2001) and more recently wrote the groundbreaking book, Trading Against The Crowd: Profiting From Fear and Greed in Stock, Futures and Options Markets (John Wiley & Sons, 2004), which includes Mr. Summa's innovative quantitative bear and bull news-flow Contrarian indicator. Mr. Summa is a PhD-trained economist and operates a delta-neutral options trading CTA program.