Can a chipmaker champion get off the mat?
05/04/17

Options traders are looking for a champion chipmaker to get off the mat following an historic beat-down.

Advanced Micro Devices (NASDAQ: AMD) started the week riding a gain of 284 percent in the preceding year. That made it the best-performing member not only in the Philadelphia Semiconductor Index and the Select Technology Index, but the entire S&P 500 over the period.

Then came earnings on Monday night. While the company sharply narrowed its losses and bolstered sales by 18 percent, analysts were looking for something even better and sellers caught AMD flat-footed the next morning. It cratered 24 percent as a result, the stock’s worst bloodletting in over 12 years.1

Buyers wasted no time in coming back to the stock on Wednesday. Placing trades early and often, they purchased the May 10.50 calls for about $0.40 and sold matching numbers of the May 11.50 calls for roughly $0.15. Hundreds of contracts steadily crossed the tape in matching blocks, totaling up to volume of more than 22,000 at each strike by the by the closing bell. 

Known as a vertical spread, the strategy is designed to generate leverage on a move to specific level. Here’s a rundown of how it works:

  • Owning the 10.50 calls grant holders the right to buy AMD stock for $10.50 by expiration on May 19.
  • Selling the 11.50s obligate them to deliver shares for $11.50 if they’re above that level on May 19.
  • So, if AMD is over $11.50, they’ll collect the $1 difference. (Buy for $10.50, sell for $11.50.) This is why it’s called a spread… 
  • It cost a net $0.25 to open the position ($0.40 - $0.15). Divide the $1 by the $0.25 cost, and you get a potential maximum profit of 300 percent profit.
  • That maximum profit level of $11.50 is less than 11 percent above AMD’s closing price of $10.39 yesterday.
  • Breakeven is at $10.75, and the entire position will expire worthless if the stock ends below $10.50.
Advanced Micro Devices (AMD) 6-month chart

Source: OptionsHouse by E*TRADE

While the broader semiconductor space has been red hot, experts credit AMD’s meteoric rise in the last year to a successful corporate turnaround and introduction of new Ryzen chips.2 Management also meets with analysts on May 16, shortly before yesterday’s call spread comes due… so those buyers may be hoping for more than just a dead-cat bounce.

In summary, AMD’s had a huge rally, and now traders are buying the pullback.

 

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1. Reuters: AMD's revenue rises 18.3 percent, but margin forecast disappoints. 5/1/17. Marketwatch: AMD's stock plunges to biggest loss in over 12 years. 5/3/17.

2. Credit Suisse: Profits Not Ryzen Fast Enough. 5/2/17. Bank of America Merrill Lynch: Slower start to Ryzen, but long-term growth opportunities intact. 5/1/17.