Increased Volatility Could Signal a Big Move Ahead
Volatility is one signal traders can look for when trying to turbocharge their portfolio. The source of volatility can sometimes be news. For example, Bloomberg reported, “Broadcom Inc. (Nasdaq: AVGO) gave an annual sales forecast that signaled optimism that the chip industry has weathered the worst of the China-U.S. trade war, but shares dropped after the company said some units are losing orders, raising concerns about overall growth.”
Bloomberg continued, “Sales in fiscal 2020, which ends next November, will be $25 billion, plus or minus $500 million, the company said [recently] in a statement.
That projection includes revenue from its purchase of a Symantec Corp. unit, and was in line with or better than estimates from some analysts who had also factored in that new division’s contribution.
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On a conference call with analysts, executives said Broadcom lost business from a big smartphone customer in one product area and warned that Wi-Fi chip sales will decline next year.
Chief Executive Officer Hock Tan has built the company into one of the biggest in the semiconductor business through a string of acquisitions, and is now expanding into software.
That gives Broadcom one of the widest reaches in technology, with clients including Apple Inc. and Samsung Electronics Co. in smartphones and some of the top data-center operators for networking components.
The evaporation of some business from one of those big phone makers will hold back revenue gains, and the company will tightly control its investment in wireless and industrial chips, Tan said on the call.
Apple is one of Broadcom’s largest customers for smartphone components, and earlier this year the two companies struck a deal to supply Apple’s products with radio frequency, or RF, chips for the next two years.
Broadcom has also long supplied Apple with Wi-Fi components. But a wireless-charging component used in Apple’s iPhone for a few years from Broadcom was replaced in newer models by a part from STMicroelectronics NV, according to breakdowns of the handset’s parts by iFixit and others. That may be the lost business Broadcom disclosed.
The company is targeting total semiconductor sales of $18 billion in 2020, Chief Financial Officer Tom Krause said on the call. The company’s core business — chips used in networking, broadband and storage systems — will grow about 7% to around $12 billion, he said.
Wi-Fi chip revenue will decline from a total of $2.2 billion and mixed-signal chip revenue will drop by half to less than $500 million, he projected. The company is predicting enterprise software sales will rise to about $7 billion. Symantec revenue will grow from a base of around $1.8 billion, he said.
Sales in the fiscal fourth quarter of 2019, which ended Nov. 3, rose 6.1% to $5.78 billion, the San Jose, California-based company said. Before certain items, profit was $5.39 a share.
That compares with average analyst estimates for per-share profit of $5.38 on sales of $5.73 billion, according to data compiled by Bloomberg.
Broadcom’s market value has swelled to $130 billion following Tan’s spree of deals, including his purchase of Symantec’s enterprise security business for $10.7 billion last month.
A big chunk of the company’s products are used in China or sent through factories there on the way to becoming part of electronic devices sold around the world.
Huawei Technologies Co., a Chinese equipment maker that has been called a security threat and was cut off from U.S. suppliers by the Trump administration, previously spent hundreds of millions of dollars a year on Broadcom chips.
Tan, who has been among the most vocal chip-industry leaders in calling out the impact of the trade dispute between the U.S. and China, trimmed Broadcom’s revenue forecast earlier this year, shaving $2 billion from his original projections, citing declining orders amid the trade dispute.”
The longer term chart using weekly data shows AVGO could be near a top and vulnerable to selling pressure.
A Trading Strategy To Benefit From Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So, this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
Every day, we scan the markets looking for trades that carry low risk and high potential rewards. These trades are available almost every day and we share them with you as we find them. Now, it’s important to remember these are trading opportunities in volatile stocks.
When we find a potential opportunity, we evaluate it with real market data. But because the trades are volatile, the opportunities may differ by the time you read this. To help you evaluate the current opportunity, we show our math and explain the strategy.
A Bear Call Spread in AVGO
For AVGO, we could sell a December 20 $315 call for about $3.63 and buy a December 20 $317.50 call for about $2.49. This trade generates a credit of $1.14, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $114 The credit received when the trade is opened, $114 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $136. The risk can be found by subtracting the difference in the strike prices ($250 or $2.50 times 100 since each contract covers 100 shares) and then subtracting the premium received ($114).
This trade in AVGO offers a potential return of about 83% of the amount risked for a holding period that is relatively brief. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if AVGO is below $315 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $136 for this trade in AVGO.