Last week I wrote about the ongoing boom in artificial intelligence (AI). The purpose of that article was to warn readers not to jump into something they don’t understand or that may be overvalued. That’s a good way to lose home.

However, it is natural to look at some of these soaring AI companies and think “Gosh, I wish I had put a few dollars into a company like Nvidia (NSDQ: NVDA) before it shot up so much.”

Some people, who may be late to the party, will inevitably talk themselves into jumping into a stock that has advanced too far, too quickly. They may buy a stock near its peak. They suffer from FOMO — fear of missing out. It’s one of those phenomena that often causes investors to lose a lot of money. They reason that they may be overpaying, but they figure the stock is going to keep going higher.

This is a situation where stock options can really help. You can sell a call close to the money, and sometimes get a substantial discount on your entry price. By doing this, you can significantly lower your risk. But you have to understand the potential implications.

Before explaining how this works, let’s review some options terminology.

Options 101

An option gives the right, but not the obligation, to buy or sell shares at a defined price and on or before a defined time. You can buy or sell options.

A person who buys a call option is buying the right to purchase 100 shares of stock. The person who sells a call is creating the obligation to potentially sell them.

Options define the price at which the trade would be executed (the strike price), the date by which the trade would occur (the expiration date), and the premium (the cost) of that option.

The share price of the stock is important since you have to have 100 share increments of any company for which you plan to use this strategy. If the share price is $4.00, an option contract represents $400 of stock. If the share price is $500, it represents $50,000 of stock.

Stock at a Discount

My strategy for using call options is to always pair them with underlying stock in a trade called a covered call. By doing so, you can purchase the stock at a discount — but there is a catch. The important thing here is that you buy yourself some downside protection.

Many of the AI companies survive when this bubble pops. But Nvidia certainly will still be standing. It’s a company that you would want in your portfolio. But maybe you don’t want to enter at the current price. The share price is up 70% just this year. If the market corrects, you could be down a lot of money in a hurry.

The big problem with Nvidia is that it currently trades at $822.79 a share. Because an option represents 100 shares, if you did a covered call on NVDA, your outlay would be in the vicinity of $80,000.

Further, since I always recommend you only keep individual position sizes to maybe 3% of your overall portfolio, that would imply you would need a portfolio of around $2.7 million to do a single NVDA covered call and not allocate too much of your portfolio to a single position ($80,000/3%).

So, what I am going to do here is for illustrative purposes only. You might have the ability to actually do this trade. But what I want to do is to show you how to use options to recapture some gains you feel you missed out on, while protecting your downside.

I am using NVIDIA because it is the highest profile stock benefiting from the AI boom. At one point, Microsoft (NSDQ: MSFT), Apple (NSDQ: AAPL), Intel (NSDQ: INTC), and lots of other companies were soaring in their fields.

The point is, if you ever saw a company, and thought “I wish I had bought into that company, but I am too late”, then here’s a way to buy in and give yourself some downside protection.

A Covered Call Example

Here is how to set up a covered call.

Last Friday, Nvidia closed at $822.79. If I look out to January 17, 2025 — 321 days from when I am writing this — I can sell an option on Nvidia with a strike price of $820 for $152. That means if I execute a buy-write on Nvidia (I buy shares and sell the call at the time). Thus, I can buy shares for a net of $822.79-$152.00 = $670.79. I have to buy 100 shares, so I need $67,079. That’s a discount of 18% from the current share price of Nvidia.

What are the possible outcomes of this trade? If shares keep soaring, then they could be called at any time between now and expiration. If called, you would get paid $820 for shares that cost $670.79. That’s a profit of 22.2% if held until expiration (25% annualized).

Or you can roll the shares at any time (buy back the call and sell a new one so you can keep the shares). I have had one position for four years that is 60% above the strike price. I have held onto the shares by keeping the expiration date at least six months away. Meanwhile, I am collecting dividends, selling calls, and I have huge downside protection if the share price crashes.

Finally, NVDA shares could correct downward. When your option expires in January 2025, shares may be below $820, and you get to sell a new call. As long as shares are still above $670.79, the initial trade would be profitable. You would continue to own one of the best companies in a very exciting field.

But again, this is simply illustrative. You can apply this lesson to any company in any industry where you feel like you missed out. If the company is moving quickly, odds are the option premiums are lucrative. Use those lucrative option premiums to carve out a big discount on the purchase price by selling a call close to the current share price (in option vernacular, “close to the money”). Then set yourself up for future gains on the company.

Just keep in mind that this is a very specific strategy designed to carve out a lot of downside protection for a stock that has risen quickly. It gives you little upside potential, but it does allow you a potential double-digit profit if you do lose your shares.

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