The video game industry has historically been extremely cyclical. Investors tend to only focus on the industry when a new console launches. 2018 might go down as the year that changes.
According to Super Data Research, monthly sales figures throughout much of this year have already surpassed console-launch years. That’s a remarkable feat in the industry known to only garner attention whenever Nintendo, Sony or Microsoft come out with a new platform.
PC gaming, on the other hand, doesn’t see as many spikes and valleys. While there are certainly some interested in new graphics cards or processors hitting the market, these don’t create the kind of boom in sales for gaming companies like a new Xbox or PlayStation does.
But with the recent mega-successes like God of War, Spider-Man and Red Dead Redemption 2, we’ve seen how individual games can drive new sales… even months and years after the console on which they launched on have been on the market.
This last point is crucial to understanding what’s happening here. These three games are all console exclusives. God of War and Spider-Man launched exclusively on the Sony PlayStation 4. Red Dead Redemption 2 is only playable on the PS4 and the Xbox One. Meaning, these huge titles are excluding the powerful PC market. Even the powerful title Fortnite has moved to mobile from PC.
Now, this hasn’t really happened outside of Nintendo games, ever. As soon as PC gaming grew into the market it is today, companies making those games made sure to port, or adapt the software, to PC. They simply aren’t doing that this year.
While this certainly affects gamers who only play on PCs, it really only has an impact on one company… at least on the hardware side.
The First Blow in Today’s Graphics War
NVIDIA is a massive, $130 billion semiconductor company. It makes a wide range of products, including chips for artificial intelligence and data centers. But it is most well known for its gaming graphics cards. It controls more than two-thirds of the graphic processing unit (GPU) market.
Simply put, that means, when PC games do well, and gamers need to upgrade their rigs to play them, NVIDIA does very well. But as we said, that’s not the case this year. In fact, the recent wave of console exclusives has many PC-only types out buying consoles for the first time in years.
And you know what the extra slap in the face for NVIDIA is with this recent buying craze of console sales? The PS4 and Xbox One are powered by NVIDIA’s chief competitor’s product, AMD. While it is too early to tell if AMD will be able to steal much market share in the long run, it does not bode well for NVIDIA’s short-term profits
As you can see, NDVA has taken a major tumble during the month of October.
Most of that, however, was industry-based. The entire semiconductor industry had a terrible several weeks. The SPDR S&P Semiconductor ETF fell 22% from peak to trough.
These exclusives driving PC gamers into consoles haven’t actually hit NVIDIA’s numbers yet. But that’s soon coming. The company reports its third quarter next week. Many analysts are worried about what might be coming… two have downgraded their Q3 NVDA EPS estimates in the past month.
Of course, nothing is certain. This earnings season has been driven by future-looking numbers rather than recent quarterly performance. And NVIDIA just launched its new graphics card series. Much of the reaction to its quarterly numbers will be about how much those new products sell going forward.
So, how do you play a company set to potentially stumble in the short term, but could surprise in a big way in the other direction?
A Strategy For Short-Term Bears
The easiest way to profit from a stock’s slide lower would be to buy a put option. This basically grants the option buyer the right to sell shares at a set price (the strike price of the put contract). So, if shares fall past that amount, they profit on every cent it goes below it. But as we noted, recent GPU launches from NVIDIA could turn this kind of trade into a complete loss.
Instead, you could hedge your downside by collecting a little income at the start of the trade. The strategy we prefer to do this is called a bear put spread.
The idea is to buy a put option with a strike price at or slightly higher than the current trading price of the underlying stock. You then sell a put option with a lower strike price to offset your expenses.
Your total risk on this kind of trade is the cost to enter it — the difference between what you pay for the put with the higher strike price and the premium you collect by selling the put with the lower strike price.
Your maximum profit would come if the underlying stock falls below that lower strike price. It would be the difference in strike prices minus your initial outlay to enter the trade. This can be extremely profitable for short-term stock dips, such as an earnings season can bring.
Here’s how that looks on a graph:
Source: The Options Industry Council
A Specific Trade For NVIDIA’s Uncertain Q3 Announcement
NVIDIA announces its third quarter on Nov. 15. So ideally, you would want to let the market’s forces have their way with it for a few days after this announcement. That means you’d have to look at the December options.
If you buy NVDA December 21 $215 puts for $17.40 per share (or $1,740 per contract worth 100 shares) and sold the December 21 $205 puts for $13.20 per share (or $1,320 per contract), your total trade debit would be $4.20 per share or $420 total. That’s your total risk.
If these recent analysts are right and shares do tumble following a bit weaker-than-expected quarter, your maximum profit would be $5.80 ($215 – $205 = $10; $10 – $4.20 = $5.80). This represents a profit of $580 per contract since each one covers 100 shares.
So, if NVIDIA moves south, you’re looking at a $580 total profit on a risk of $420 per contract. That works out to a 138% return on your risk.