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This Trade War Victim Could Create a Low Risk Trade

This Trade War Victim Could Create a Low Risk Trade

News about the trade war will be in the headlines for some time and the news will create opportunities for traders willing to consider short term trading strategies.

According to Barron’s, Skyworks Solutions (Nasdaq: SWKS) and Qorvo may permanently lose chip business with Huawei Technologies, Susquehanna Financial Group believes.

SWKS was down on the news.

SWKS daily chart

The two chip makers make radio-frequency semiconductors, which enable smartphones to communicate with wireless networks. Huawei is one of the biggest producers of smartphones and telecommunications infrastructure in the world, but in May, President Donald Trump signed an executive order that put the company on an export blacklist due to national-security concerns.

Competition is also increasing, as CNBC noted,

Alibaba unveiled its first chip to power artificial intelligence (AI) processes on Tuesday. The move could boost its already fast-growing cloud computing business and signals China’s growing ambitions in developing its own homegrown semiconductor industry.

The chip, called the Hanguang 800, can cut down computing tasks that would have usually taken an hour, down to just five minutes, the e-commerce giant claims.

Alibaba said that the chip is currently being used internally within the company’s business operations, especially in product search and automatic translation on e-commerce sites, personalized recommendations, advertising, and “intelligent customer services.” These are areas that require extensive computing tasks and the chip can help speed things up.

“In the near future, we plan to empower our clients by providing access through our cloud business to the advanced computing that is made possible by the chip, anytime and anywhere,” Jeff Zhang, Alibaba’s chief technology officer, said in a press release.

The launch of AI chips by Alibaba and Huawei — two of China’s largest tech companies — highlights the country’s ambitions to create its own homegrown semiconductor industry. Currently, Chinese companies rely heavily on American technology, but the Washington’s move to blacklist Huawei and restrict its access to American tech has increased China’s focus on chips.

Beijing highlighted semiconductors as a key area of the “Made in China 2025” plan, a government initiative that aims to boost the production of higher-value products. China aims to produce 40% of the semiconductors it uses by 2020 and 70% by 2025.

SWKS appears to be in a downtrend and could see additional down side.

SWKS weekly chart

A Trade for Short Term Bulls

As with the ownership of any stock, buying SWKS 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.

bull call spread

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 SWKS

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 SWKS, the November 15 options allow a trader to gain exposure to the stock.

A November 15 $75 call option can be bought for about $6.60 and the November 15 $77.50 call could be sold for about $4.70. This trade would cost $1.90 to open, or $190 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 $190.

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 SWKS the maximum gain is $0.60 ($77.50 – $75= $2.50; $2.50 – $1.90 = $0.60). This represents $60 per contract since each contract covers 100 shares.

Most brokers will require minimum trading capital equal to the risk on the trade, or $190 to open this trade.

That is a potential gain of about 31% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.