Big options traders move in for chip stock drop

Chipmakers started the year with a bang, but now traders are wondering if the sector will take a break.

The Philadelphia Semiconductor Index rallied 12 percent in the first quarter as industry sales showed their biggest gains in over six years.1 Strong demand for smart phones, videogames, cloud computing, and a rebound in PC shipments were all credited with the surge.

But things can change quickly: Since the second quarter began, the sector’s down 3 percent. Analysts have turned negative on some key high-fliers in the space and the news surrounding tech heavyweight Apple (NASDAQ: AAPL) has gone from being a tailwind to a headwind. Consider these recent headlines:

  • April 4: Pacific Crest downgrades NVidia (NASDAQ: NVDA). Yes, that NVDA, the same one that rallied more than 400 percent between mid-2015 and early 2017. Sell it, the party’s over, said PacCrest.2
  • April 6: Goldman Sachs initiates Advanced Micro Devices (NASDAQ: AMD) as a “sell.”3 After all, it was up 400 percent in just the last year…
  • April 10: BMO warns NVDA faces slowing videogame demand.4
  • April 11: Credit Suisse slashes On Semiconductor (NASDAQ: ON) two notches to “underperform” and says industry growth will peak in June.5

AAPL poses another potential issue to chip makers. On April 5, it cut ties with one key supplier and another fell this week on concerns it may get the axe as well.6 So far the affected companies have been foreign, but several U.S. firms also depend on its business. On top of that, AAPL is ensnarled in an increasingly complex legal fight with Qualcomm (NASDAQ: QCOM).7

Semiconductors and S&P 500, 6-month chart

Source: OptionsHouse by E*TRADE

Yesterday the caution spread to the options market as traders positioned for potential downside in Applied Materials (NASDAQ: AMAT), the world’s top supplier of chip-making tools and equipment. The first transactions were detected minutes after the opening bell, with 3,600 October 35 puts changing hands for $1.54 to $1.70. About two hours later, buyers snapped up 4,000 of the April 36.50s puts for $0.18 to $0.20.

Puts lock in the price where investors can sell a security, so they can appreciate when shares decline. If a stock bounces, holds its ground or doesn’t depreciate enough, the puts will expire worthless. AMAT fell 1.70 percent to $38.20 yesterday. If it declines another 16 percent to $32 by October expiration the 35 puts could potentially double in value. (Their breakeven is around $33.40.) 

The April 36.50s have much greater potential returns but also much less time to work. Their breakeven is around $36.30 and only need a drop of 5.50 percent by the end of next week to double. (If AMAT stays over $36.50 the puts go to zero.)

Bottom line: Semiconductors were on fire in Q1, but the price action has slowed this month and a couple of big investors are positioning for a potential drop in a key supplier. 

1. Semiconductor Industry Association: Global Semiconductor Sales Up 16.5 Percent Year-to-Year. 4/3/17.

2. Nvidia Downgraded; Shares Undercut Key Support Level. 4/4/17.

3. Goldman Starts Advanced Micro Devices At Sell, Sees 20% Downside. 4/6/17.

4. Barron's: Nvidia: GPU Weakness May Come Early, Says BMO. 4/10/17.

5. Bloomberg: ON Semi Falls; Cut at Credit Suisse on Peak Industry Growth. 4/11/17.

6. Apple clash with Imagination Technologies shows desire to take 'control of their destiny' in future of A.I. 4/5/17. Apple supplier tanks 36% amid fears it could lose its key contract. 4/11/17.

7. Reuters: Qualcomm hits back at Apple's lawsuit, accuses iPhone maker of false statements. 4/11/17.