This Tech Stock Could Deliver a Gain of More than 80%
Analysts closely follow earnings reports because an emphasis on the earnings per share is not enough. There are additional derails in the report and the additional details can often trigger a significant move. Sometimes the detail can be a better than expected forecast for upcoming quarters. That was the case recently as Bloomberg reported when “Applied Materials Inc. (Nasdaq: AMAT) gave a sales forecast for the current quarter that topped analysts’ estimates, suggesting a slump in orders for chipmaking equipment is ending.
The company is the largest maker of machinery used in the manufacture of semiconductors, which are among the most important parts of the electronics supply chain.
Customers of the company include Samsung Electronics Co., Intel Corp. and Taiwan Semiconductor Manufacturing Co., giving it a reach that makes its results and forecasts an important early indicator of business confidence.
Intel and other chipmakers order equipment months in advance of starting new factories and production lines.”
Bloomberg noted there were several key insights available from the announcement,
“Fiscal first quarter sales will be about $4.1 billion, Applied Materials said [recently] in a statement. That compares with analysts’ average estimate of $3.71 billion, according to data compiled by Bloomberg.
Adjusted earnings per share will be 87 cents to 95 cents, the company said. Analysts projected 75 cents a share.
The results “reflect a healthy uptick in demand for semiconductor equipment, combined with strong execution across the company,” Chief Executive Officer Gary Dickerson said in the statement. Chip-equipment makers often experience wild earnings swings.
Machines cost tens of millions of dollars each. Delaying factory build outs is one of the fastest ways a chipmaker can preserve cash when they’re unsure of future demand.
Net income was $698 million, or 75 cents a share in the period ended Oct. 27, compared with $757 million, or 77 cents a share, a year earlier. Revenue was little changed at $3.75 billion. Analysts were looking for $3.68 billion.”
Shares rose after the announcement, extending the bullish trend in the stock and the stock is now up more than 70% since the beginning of the year.
The weekly chart shows the breakout potentially completes an important bottoming pattern.
A Trade for Short Term Bulls
As with the ownership of any stock, buying AMAT 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 priced stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for AMAT
Every day, we scan the markets looking for trades with 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.
For AMAT, the December 20 options allow a trader to gain exposure to the stock.
A December 20 $62.50 call option can be bought for about $1.70 and the December 20 $65 call could be sold for about $0.82. This trade would cost $0.88 to open, or $88 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 $88.
The maximum gain on the trade in AMAT is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in AMAT the maximum gain is $1.62 ($65 – $62.50= $2.50; $2.50 – $0.88= $1.62). This represents $162 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $88 to open this trade.
That is a potential gain of about 84% in AMAT, based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.