Why the C3.ai (AI) Bull Put Spread Could Be the Smartest Way to Play the Market

(Originally published on Sept. 2, 2024 in the Stockvora substack)

In the evolving landscape of artificial intelligence, few companies are as relevant as C3.ai ($AI). Specializing in turnkey machine intelligence solutions for enterprise clients, C3.ai has firmly positioned itself as a significant player in the AI ecosystem. However, despite the hype surrounding AI technologies, AI stock hasn't seen the kind of bullish performance investors hoped for. In fact, it has struggled, raising questions about the sustainability of the AI frenzy.

The AI Hype Train May Be Losing Steam

Part of the reason behind C3.ai's lackluster performance stems from a broader market trend—investors seem to be cooling on AI stocks. The perfect example of this comes from Nvidia ($NVDA), the semiconductor giant that has played a key role in AI innovation. Recently, Nvidia delivered solid results for its second-quarter earnings, exceeding expectations with adjusted earnings per share (EPS) of 68 cents versus 64 cents expected. Revenue came in at $30.04 billion, surpassing analysts' estimates of $28.7 billion.

Despite this strong financial performance, NVDA stock slipped in the after-hours trading session following the earnings announcement. This indicates that even Nvidia, which is at the heart of AI developments, couldn't sustain its momentum. The low-hanging fruit of the AI revolution may already be harvested, and now investors are looking for the next wave of transformative innovation.

C3.ai, unfortunately, hasn't been able to respond as effectively as companies like Nvidia. The speculative AI wave seems to be waning, leading to bearish sentiment for companies involved in artificial intelligence, including C3.ai. Nevertheless, the business case for AI remains intact, and this duality creates an opportunity for options traders to benefit from both the positive and negative catalysts surrounding AI stock.

A Bull Put Spread Could Take Advantage of Sideways Movement

Given the clashing dynamics—C3.ai's relevance in AI versus the fading hype—the stock could find itself trading sideways for the foreseeable future. For this reason, a bull put spread offers an intriguing strategy for options traders who want to take advantage of this uncertainty while generating income with limited risk.

A bull put spread involves selling a put option at a higher strike price while simultaneously buying a put option at a lower strike price, both with the same expiration date. The goal is to collect premium from the sold put while hedging potential downside with the bought put. If the stock stays above the higher strike price, you pocket the premium. If it dips below, your downside is limited by the protective put you purchased.

For C3.ai, here are the specifics of a possible bull put spread:

• Expiration Date: September 6, 2024

• Sell the $20 put at a bid price of 37 cents

• Buy the $19 put at an ask price of 22 cents

Let’s break down the core stats for this trade.

• Net Premium Collected: The net premium received from this trade would be 15 cents (37 cents from selling the $20 put minus 22 cents for buying the $19 put).

• Breakeven Price: The breakeven price for this trade is $19.85. This is calculated by subtracting the net premium of 15 cents from the higher strike price of $20.

• Max Profit: The maximum profit in this bull put spread is the net premium collected—15 cents per share or $15 per contract.

• Max Loss: The maximum loss is the difference between the strike prices (in this case, $1) minus the premium received. So, the maximum loss would be 85 cents per share or $85 per contract.

• Risk-Reward Ratio: The risk-reward ratio for this trade is approximately 5.67:1 ($85 max loss divided by $15 max profit).

This bull put spread offers a reasonable balance between risk and reward, capitalizing on the idea that C3.ai is unlikely to dip below $20 in the near term, while still protecting against downside risks.

Technical Analysis: Is AI Stock Bound to Move Sideways?

From a technical standpoint, C3.ai stock is sitting at a crossroads. The stock appears to have solid support at the $20 price level, a level it has tested multiple times over the past few months. This means that even with the broader uncertainties around AI, there’s a good chance AI stock will hold above $20, lending further support to the bull put spread.

On the flip side, C3.ai has encountered significant resistance around the $26 to $27 range. Unless the company provides more convincing fundamentals or the market sees another AI catalyst, it may be difficult for AI stock to break out of this resistance zone. Therefore, with strong support at $20 and resistance around $26 to $27, there’s a high likelihood that AI stock will move sideways for the foreseeable future. This makes the bull put spread particularly attractive for those looking to generate income without needing a massive upside move.

Volatility and Its Implications for the Bull Put Spread

Another element to consider is the volatility of AI stock. The implied volatility for the September 6, 2024, options chain is 32.55%, which is significantly lower than the historical volatility of 42.09%. This discrepancy suggests that the market is pricing in less uncertainty in the future than what has occurred in the past.

Lower implied volatility can be a positive for options sellers, as it typically translates to lower premiums but also indicates reduced expectations for wild price swings. This environment benefits bull put spreads, as the strategy performs best when the underlying stock stays within a relatively narrow range, which seems to be the case for AI stock.

Conclusion: A Balanced Approach to an Uncertain Market

C3.ai may not be a rocket ship stock at the moment, but that doesn’t mean investors should write it off entirely. With strong support at $20 and a broader AI narrative still unfolding, the company remains relevant. At the same time, with resistance overhead and the AI hype cooling off, it’s equally plausible that AI stock could continue to move sideways.

This is where a bull put spread comes in handy, offering the chance to collect income while minimizing downside risks. By selling a put at $20 and buying a protective put at $19, you can structure a trade with an attractive risk-reward profile, poised to benefit from sideways movement.

Disclaimer:

Stock trading involves significant risks and is not suitable for every investor. The strategies and ideas discussed in this article are for informational and educational purposes only and should not be construed as financial or investment advice. Always conduct your own research or consult with a licensed financial advisor before making any investment decisions.

Please note that selling options can expose you to unlimited liability if the underlying asset moves against you. It is crucial to exercise your in-the-money bought options to offset the potential liability of your in-the-money sold options, particularly in volatile markets. Make sure you fully understand the risks and mechanics of options trading before engaging in these types of transactions.