A Trading Strategy for AMD’s Newest Computer Chip
Computer chips are the work horse of the twenty first century. Chips power the laptop this article is being written on; the server the article is posted to; the phone, tablet or computer you are using to read the article; and every step in the process along the way.
Chips extend far beyond computers in the modern world. They are also now used in cars and many other everyday items. In these devices, their growth is exploding. One way to visualize how ubiquitous computer chips have become is to look at how complex computer code is.
The chart below, from 2014, shows that cars contain 100 million lines of code and manufacturers will require millions of chips every year to process that code.
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Demand is growing and suppliers are stepping up efforts to meet demand with improved technology.
Technology Leadership May Be Changing
Advanced Micro Devices Inc. (Nasdaq: AMD) has been a consistent technology leader although the company has significantly lagged market leader Intel in sales for chips used in desktop systems. CPU Benchmark reports that AMD has settled into a small market share of about 20% over the past few years, down from a 50% share in 2006.
This may be a small market share but it is a small share of a large market. AMD estimates the size of the market at about $18 billion a year.
In addition to size, AMD benefits from loyalty within the market. The company has strength in several niche market segments that are unlikely to shift to Intel. Gaming, in particular, is an area where AMD has an entrenched leadership position.
Gaming PCs have strict requirements for processing speed and it is a significant market, but not large enough to entice Intel to concentrate on. That means AMD should be a stable operating company for quite some time.
Another factor ensuring AMD’s survivability in the long run is the fact that Intel needs competition to avoid antitrust concerns. This means AMD could be attractive to other, larger companies who realize the company could be a profitable operating division within a larger company.
While AMD is attractive in the long run, there is also a short term trading opportunity in the stock. This month, the company is officially launching a new chip for servers, a product the company is calling EPYC.
While Intel has a 99% market share in server chips, AMD is fighting for a larger piece of that business. Server chips generally have the highest average selling price for chips and better profit margins than lower priced chips.
According to analysts, EPYC has more capacity than Intel’s high end chips. While neither AMD nor Intel have released the complete specs for their server chips, it is known that EPYC will have 32 cores and 64 threads, more than Intel’s upcoming Skylake-EP which is expected to have 28 cores and 56 threads. For server applications, the extra 4 cores should significantly improve performance.
EPYC also has more memory with a 64 MB L3 cache compared to Skylake-EP’s expected 38.5MB. Analysts believe the larger L3 cache will improve EPYC’s performance in many applications.
The EPYC chip is also more capable for machine learning applications with 25% more capacity than Intel’s product for this application.
Gains in power come from a new technology, Infinity Fabric, that AMD pioneered. This technology breaks a large number of server cores into smaller groups. By connecting multiple cores into a multi chip module, AMD is taking technology to the next level.
The company provided a direct comparison to the competition in a recent presentation.
One analyst noted, that “AMD has compelling server solutions that can take meaningful market share away from Intel. However, the market today does not trust that AMD can meaningfully attack Intel when it comes to servers. The server customers are seen as too conservative to accept AMD solutions quickly.
While there is some truth to this, we believe the market is underestimating how quickly the cloud server market can move (as opposed to slow moving enterprise space).”
If a major cloud customer like Facebook, Amazon, Apple, Netflix or Google signs up for AMD machines, the stock price could soar. Without these customers, the stock is capable of delivering slow gains.
A Trading Opportunity
Options provide an ideal tool for trading AMD.
Many larger companies offer options trading a year or more in the future. With more time to expiration, these options offer a higher probability of having value when they expire. In that way, an option with a long time frame to expiration carries less risk than an option that expires in a matter of days or weeks.
One potential pitfall with trading options that expire a year or more from now is that they can be more expensive than options that expire in the next few weeks.
A long calendar spread can overcome this concern.
This strategy uses two options. It is a suitable strategy for those times when a trader has a bullish outlook for the long term and is expecting a relatively mixed picture in the shorter term. This is one opinion for AMD.
In the long term, the stock appears to be extremely undervalued and capable of delivering a large gain. In the shorter term, the stock could sell off slightly, move into a trading range or move higher.
If the new chip fails to meet expectations, traders may decide to sell the stock. Because of the bullish long term outlook for profits, any potential selling is likely to be relatively mild and the prospects of a steep decline in the stock price appear to be slim.
If traders believe the new chip will not have a material impact in the next quarter or so, the stock price of AMD could settle into a trading range.
If the chip is well received or a large number of orders are announced, the stock price could soar.
A long calendar spread is a strategy that could deliver a profit under any of these possible scenarios. This strategy is specifically designed for a longer term bullish outlook with a near term neutral/bearish outlook. To open the spread, a trader buys a call that expires in the more distant future and sells a call that expires in the relatively short term.
If the underlying stock rises slightly, remains steady or declines during the life of the near-term option, that option will expire worthless and leave the investor owning the longer-term option free and clear. The maximum possible gain on this strategy is, in theory, unlimited as any strategy that in effect owns a stock is.
On the downside, the maximum risk in the position is equal to the amount of money paid to open the trade.
This strategy is ideal for investor who would like to reduce the cost of purchasing a longer term call option.