A New Technology Can Highlight New Trades And Gains
Trade summary: A bull call spread in Advanced Micro Devices, Inc. (Nasdaq: AMD) using the May 15 $55 call option which can be bought for about $4.08 and the May 15 $60 call could be sold for about $2.05. This trade would cost $2.03 to open, or $203 since each contract covers 100 shares of stock.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $203. The maximum gain is $297 per contract. That is a potential gain of about 46% based on the amount risked in the trade.
Now, let’s look at the details.
Sometimes, rather technical news can boost a stock. One example is recent news from GlobeNewswire
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“AMD announced it is extending the 2nd Gen AMD EPYC processor family with three new processors that combine the balanced and efficient AMD Infinity architecture with higher speed “Zen 2” cores for optimal performance on database, commercial high-performance computing (HPC) and hyperconverged infrastructure workloads.
The three new processors, the AMD EPYC 7F32 (8 cores), EPYC 7F52 (16 cores) and EPYC 7F72 (24 cores), expand 2nd Gen AMD EPYC performance leadership into workloads that can leverage up to 500 MHz of additional base frequency, and large amounts of cache, making AMD EPYC the world’s highest per core performance x86 server CPU.
The AMD EPYC 7Fx2 processors provide new performance capabilities for workloads in the heart of the enterprise market including database with up to 17% higher SQL Server performance compared to the competition, hyperconverged infrastructure with up to 47% higher VMmark 3.1 score (using vSAN as the storage tier in a 4-node cluster) compared to the competition for a new world record and commercial high-performance computing (HPC) with up to 94% higher per core computational fluid dynamics individual application performance compared to the competition.”
As a trader, it’s fair to ask what this means. The answer is that new products, especially when coupled with new highs in price, can serve as a buy signal in a stock. The chart of AMD supports the opinion that AMD could be considered a buy.
The chart is showing a possible cup with handle pattern which consists of a pullback from highs that forms a shallow base and then resumes the up trend. The weekly chart, shown below, includes a cup with handle pattern that formed in the summer of 2018. That pattern was followed by a strong price move.
In the current market environment, risks are high and cup with handle patterns are wider than the ideal pattern which looks for pullbacks of about 8% to 10%. Few stocks pulled back that little with almost all publicly traded stocks dropping at least 20% in the March selloff.
Given the volatility in the stock market, strategies that focus on risks could be ideal.
A Specific Trade for AMD
For AMD, the May 15 options allow a trader to gain exposure to the stock. This trade will be open for about six weeks and allows for traders to turn over capital quickly, potentially compounding gains several times a year.
A May 15 $55 call option can be bought for about $4.08 and the May 15 $60 call could be sold for about $2.05. This trade would cost $2.03 to open, or $203 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $203.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in AMD the maximum gain is $2.97 ($60- $55= $5; 5 – $2.03 = $2.97). This represents $297 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $203 to open this trade.
That is a potential gain of abou 46% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
A Trade for Short Term Bulls
As with the ownership of any stock, buying AMD could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but AMD the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.