NVDA Stock Looks Tired and Toppy After a Monster Rally

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Shares of Nvidia (NASDAQ:NVDA) handily beat earnings expectations on May 21. Yet, despite the beat on both the top and bottom lines , NVDA stock fell after the news.

Source: Hairem / Shutterstock.com

This is a perfect example of the news already being more than priced into the stock. Once the upside momentum failed to take shares higher, the sellers stepped in. Look for NVDA stock to continue to struggle over the coming weeks as the momentum melt up fades.

Valuation View

Nvidia is certainly not cheap from a valuation perspective. NVDA stock now trades at a Price/Sales multiple that exceeds 18. This is by far the richest multiple in the past five years and well above the five-year average of roughly 10x. Other valuation metrics, such as P/E and Price/Book, at a similar extremes. NVDA has a P/E of over 45x, even on a forward basis. It will be difficult for Nvidia to maintain the growth needed to justify such lofty valuations.

Matt McCall and the InvestorPlace research staff published an outstanding analysis on NVDA on May 26. They highlight all the reasons to like NVDA stock for the long term, which I actually tend to agree with. McCall and staff also note similar valuations concerns as well, but ultimately dismiss them from their longer-term investment outlook.

As a shorter-term trader, however, I think these concerns are being reflected in the recent price action in NVDA stock. While longer term Nvidia may indeed head much higher, I feel the path of least resistance shorter term is lower. My downside short-term price target is $315.

Technical Take

NVDA stock reached overbought conditions before finally weakening the past several days. The nine-day RSI got to well over 70 then headed lower. MACD was at a recent extreme then turned down. It also just went negative which generated a sell signal. Momentum plateaued near annual highs before it weakened as well. Nvidia shares are trading at a big premium to the 50-day moving average which has signaled pullbacks in the past.

Source: The thinkorswim® platform from TD Ameritrade

Most importantly, NVDA stock had a key reversal day on May 26. Shares made fresh new all-time highs at $367.27 before finally weakening to close sharply lower (and near the lows) at $348.71. This type of price action is called a key reversal day and is a reliable indication that the prior trend may be coming to an end. It is even more powerful, given the magnitude of the previous rally. The buyers may finally be exhausted and the sellers have taken control.

In my previous analysis on NVDA stock from March 24, I had a decidedly bullish outlook for Nvidia. NVDA was oversold technically and had much more acceptable valuation multiples. Now that the stock has rallied more than 100 points since then, my outlook has changed as well because price does matter. A pullback toward the breakout area at $315 seems like the most likely path for NVDA stock from here.

Implied volatility (IV) has come down strongly post earnings in NVDA options. IV now sits at just the 22nd percentile, meaning option prices are comparatively cheap. This favors long option strategies when constructing trades. So to position for a pullback in NVDA stock, a defined risk put diagonal spread makes probabilistic sense.

NVDA Stock Trade Idea

As for NVDA stock trade ideas, consider this: Buy July $315 puts and sell June $310 puts for a $6.40 net debit.

Maximum risk on the trade is $640 per spread. Ideally, NVDA stock closes near $310 at June expiration on June 19 to realize the maximum potential gain. The trade structure allows additional selling of weekly put options against the long July puts to further hedge the position and reduce the initial cost after the June options expire. An uptick in IV will also benefit the trade.

As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a weekly option and volatility newsletter can visit the Options and Volatility Newsletter website.