New Recommendation, New Product and New High Point to a Trade
Trade summary: A bull call spread in Advanced Micro Devices, Inc. (Nasdaq: AMD) using the March 20 $55 call option which can be bought for about $2.81 and the March 20 $57.50 call could be sold for about $1.86. This trade would cost $0.95 to open, or $95 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 $95. The maximum gain is $155 per contract. That is a potential gain of about 63% based on the amount risked in the trade.
Now, let’s look at the details.
In the 1990s, the CAN SLIM investment strategy was popular. Each letter summarized the factor investors looked for. The most important factor was the N, which stood for new highs, new products or new managements. Newness often boosted a stock.
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Recently, Goldman Sachs made the case for tech stocks. Market Watch noted the firm “maintains an overweight rating on the sector, implying that investors should continue to buy assets associated within the buzzy tech group.
The sector’s recent gains “still pales in comparison to the Tech Bubble.” Over the past five years, the sector has returned 149%; between 1995 and 1999, the sector returned nearly 700%.
…the tech group’s forward price/earnings ratio trades at a 22% premium to the S&P 500 now, on a relative basis, the analysts wrote, below the long-term average of 31%.
Goldman also makes the case that one key differentiating factor between this run-up for tech and the five-year stretch from the late 1990s to early 2000s is the underperformance endured by information tech names in the five-year phase after the financial crisis.
Goldman also debunks a popular notion: that the recent tech rally has been concentrated in just a few companies. The top five information tech stocks account for 12% of the trailing 3-month return, a ratio that’s lower than at earlier periods of extremes, including not just 2001, but 2012, 1996, and 1991.
For those reasons, Goldman is advising its clients to increase its tech holdings, which may run against conventional wisdom, given the seemingly unrelenting rally in the sector.
Goldman recommends “exposure to either a further cyclical rebound (tech hardware and semiconductor shares) or a modest economic growth environment (software and services.).” The firm likes companies with “high and stable sales growth, high [return on equity], and trade at reasonable valuations.” AMD is on that list.
A New Chip Adds to the Case
GlobeNewswire reported that “AMD announced the AMD Radeon™ Pro W5500 workstation graphics card, delivering the performance and advanced features demanded by today’s Design & Manufacturing and Architecture, Engineering & Construction (AEC) professionals. AMD also announced the AMD Radeon™ Pro W5500M GPU, designed and optimized to power next-generation, high-performance professional mobile workstations.”
AMD stock is now near a new high and formed a small cup and handle pattern, another component of the CAN SLIM strategy.
The weekly chart shows the recent gain is consolidating and potentially setting up another up move.
A Specific Trade for AMD
For AMD, the March 20 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 March 20 $55 call option can be bought for about $2.81 and the March 20 $57.50 call could be sold for about $1.86. This trade would cost $0.95 to open, or $95 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 $95.
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 $1.55 ($57.50- $55= $2.50; $2.50 – $0.95 = $1.55). This represents $155 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $95 to open this trade.
That is a potential gain of about 63% in AMD, 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.