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How Much Will Nvidia's Stock Price Fall in a Market Crash/Decline. What About Hedging Strategies?


 

Summary:

  1. Nvidia's stock price may fall by 35.7% (average) in the next market crash/decline, as per the data.

  2. Confidence interval (mean) reveals that the range for the decline in the next crash is expected to be between 12 and 59 percent, with 98% confidence level.

  3. VaR Analysis, hedging strategies, & put options, are discussed in the report.

  4. Short-term analysis is also included.

 

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This report examines the expected decline of Nvidia’s stock (NVDA) in a market crash/decline. A market crash/decline can always be around the corner, and an accurate understanding of potential decline can aid us in formulating proper hedging strategies.


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Long term analysis

In our previous report on the assessment of average stock market crashes (see: How Much Do the US equities Fall/Decline on Average in a Crash?), the data examined indicated that the average decline, i.e., the average decline for the entire US equity market stands at 25.5%, with a 98% confidence interval range standing at 8.5%-42%.


This report, however, uses the insights from “How Much Do the US equities Fall/Decline on Average in a Crash?” to determine the expected fall of Nvidia’s (NVDA) stock in the next market crash.


The first element required in this analysis, of course, is the beta of NVDA in relation to the overall market. The beta calculation (weekly) returns, for the past 5 years, establishes a beta of 1.4 for Nvidia (see data attached at the end of the report).


Nvidia Stock Beta, Nvidia Stock Beta Wilshire 5000
Beta Calculation

Fundamental Values:

So, how much is Nvidia (NVDA) expected to fall in a market crash?

Utilizing data from our previous report, we can state that, on average, as per the assessment of over 100 years of market crashes (see: How Much Do the US equities Fall/Decline on Average in a Crash?), and 5 years of data for the determination of beta or covariance of Nvidia (NVDA), with the overall market, we can claim that Nvidia’s stock price (NVDA), is expected to fall 35.7%, on average, in a market crash.


Furthermore, as per the data, we can state with 98% confidence that Nvidia’s stock price will fall in the range of 12% to 59% in the next market crash, as per the data assessed.


In terms of strategizing and risk mitigation, our recommendation is to use the 35.7% average decline in a risk assessment. Nonetheless, in the worst case, the stock can fall 59%, or even more in a ‘once in a lifetime’ type of a crash (black swan event). We can state, however, that we are 98% certain, as per the data, that the maximum decline would be about 59%.


Thus, for every $1000 invested in Nvidia (NVDA), an investor is at risk of losing $357 on average, peak to troughs, in a market crash (base-case). In the best-case, in a market decline, the investor can lose $120, peak to troughs, and in the worst case (98 percent confidence level), the losses may amount to $590, peak to troughs, per $1000 invested. However, for increased precision value at risk analysis (VaR, primarily, measures the expected losses per a specific confidence level) has also been conducted. Value at risk (VaR) analysis


As per the results of the VaR calculations, we can confidently state that monthly losses, 95% of the time, are expected to be lower than or equal to about -25% of the amount invested in this stock, or $249.37 per $1,000 invested.


The annual VaR figure, on the other hand, stands at a very serious -83%, or per $1,000 invested in the subject, losses, 95% of the time, are expected to be lower than or equal to $863.84.

There remains a 5% probability, nonetheless, of losses exceeding the above-mentioned values; put another way, the above-mentioned values could be the lowest amount of losses 5% of the time.

Highest historical decline & appreciation


The worst monthly decline of NVDA stands at about -48.7% (6/1/2002), a very concerning figure. The best monthly appreciation stands at +83% (5/1/2003).


As this is a high volatility and beta stock, investors should stay vigilant and understand that dramatic moves are likely.


As per the data of the last 2+ decades (2000 onwards), 95% of the time losses have been below -24% per month. This also means that the observed data supports the results of the VaR Calculations.


A further critical point:


As NVDA has significant involvement in the cryptocurrencies space, it's share price can fluctuate significantly in relation to movements in the crypto space. See our relevant report on crypto to gain further insights.

Hedging the risk


Presently, put options that can be used to mitigate downside risk, 6-7 months in the future, are priced at about 14% of the share price. To protect her position against downside risk, an investor must pay about $80 per share for acquiring a put option.


If there is a crash, and the price of Nvidia falls by the average decline value of 35.7%, with a share price of $580, the investor would cover her losses of $207 per share, through the acquired puts, with the average loss per share being the price of the put options of 14% of the share price, or $80. The real question, of course, would be the economic logic of acquiring the put options.


The long-term average growth rate (past decade) of the entire US equity market, as measured through Wilshire 5000, stands at 11.8% (Reference); with a beta of 1.4, we should expect an annual appreciation of NVDA of about 16.5%. Of course, once we subtract the expected appreciation of the stock from the cost of the put option, required to eliminate the risk from the trade, we get a 2.5% profit figure, the same as the expected yield of risk-free bonds, and in the same ball-park as long-term inflation. Once again, foresight and fundamental economic analysis are revealed as holding the highest importance in portfolio management.


While for the short-term, for example, due to immediate concerns, news, etcetera, an investor may hedge against downside risk through acquiring put options, long-term, of course, this strategy isn’t viable. While some complex algorithmic options strategies are still used by hedge funds, for example, these strategies aren’t viable for smaller investors or for portfolios under $3 million.


See also:


Do all Assets Fall in a Market Crash


Which Stock Index/Index Funds/ETF Provides the Best Risk-Adjusted Returns & Diversification?


AMD Analysis


For further information on complex hedging strategies, Contact Us.



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