This Stock Looks Ready to Soar
Often, it takes a combination of factors for a stock to make a big move. For example, it could be a combination of a new product and an important technical pattern.
Those two elements could be coming together for Advanced Micro Devices (Nasdaq: AMD).
A Technical Product Leader
According to e3zine.com, a specialized IT news source:
“AMD demonstrated its commitment to datacenter computing innovation at its recent Next Horizon event in San Francisco by detailing its upcoming 7nm compute and graphics product portfolio designed to extend the capabilities of the modern datacenter.
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During the event, AMD shared new specifics on its upcoming Zen 2 processor core architecture and detailed its revolutionary chiplet-based x86 CPU design. Furthermore, it launched the 7nm AMD Radeon Instinct MI60 graphics accelerator. It also provided the first public demonstration of its next-generation 7nm EPYC server processor codenamed “Rome”.
Amazon Web Services (AWS) also joined AMD at the event. Together, they announced the availability of three of its popular instance families on the Amazon Elastic Compute Cloud (EC2) powered by the AMD EPYC processor.
“The multi-year investments we have made in our datacenter hardware and software roadmaps are driving growing adoption of our CPUs and GPUs across cloud, enterprise and also HPC customers,” said Lisa Su, president and CEO of AMD.
“We positioned ourselves well to accelerate our momentum as we introduce a broad, powerful portfolio of datacenter CPUs and also GPUs featuring 7nm process technology over the coming quarters.”
A Potential Stock Market Leader
Meanwhile, ZACKS reports that investors in the stock appear to be positioned for a large price move. That is based on the fact that AMD call options recently recorded an unusually high level of implied volatility.
Implied volatility shows how much movement the market is expecting in the future. Options with high levels of implied volatility suggest that investors in the underlying stocks are expecting a big move in one direction or the other.
It could also mean there is an event coming up soon that may cause a big rally or a huge sell-off. However, implied volatility is only one piece of the puzzle when putting together an options trading strategy.
The service notes that, “clearly, options traders are pricing in a big move for Advanced Micro Devices shares, but what is the fundamental picture for the company?
Over the last 60 days, three analysts have increased their earnings estimates for the current quarter, while seven have dropped their estimates. The net effect has taken our Zacks Consensus Estimate for the current quarter from 10 cents per share to 9 cents in that period.
Given the way analysts feel about Advanced Micro Devices right now, this huge implied volatility could mean there’s a trade developing.
Oftentimes, options traders look for options with high levels of implied volatility to sell premium. This is a strategy many seasoned traders use because it captures decay. At expiration, the hope for these traders is that the underlying stock does not move as much as originally expected.”
The stock has been forming a base in the short term.
In the longer term, the stock offers significant potential and could return to the highs seen just a few months ago.
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 has 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 prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for AMD
For AMD, the December 21 options allow a trader to gain exposure to the stock.
A December 21 $23 call option can be bought for about $0.80 and the December 21 $25 call could be sold for about $0.38. This trade would cost $0.42 to open, or $42 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 $42.
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 $1.58 ($25 – $23 = $2; $2 – $0.42 = $1.58). This represents $158 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $42 to open this trade.
That is a potential gain of about 376% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.