AMD: A Trade Strategy

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About: Advanced Micro Devices, Inc. (AMD), Includes: INTC, NVDA
by: The DeltaAviator's View
Summary

AMD stock is poised for upside.

Here is how one can participate in upward movement of AMD without the immediate full capital risk of owning the stock.

AMD's upcoming earnings release of April 25 is the catalyst for this trade.

I'll show 3 option strategies that could be used.

Advanced Micro Devices (AMD) is a well-covered company here at Seeking Alpha, and I am not about to reiterate and regurgitate all the issues of AMD here. Instead, I would like to offer a trading strategy that allows for an investor who is long AMD to participate in what I believe is an upcoming upward movement in the stock without having to immediately purchase AMD shares.

AMD poised for upside. Here's the set up.

For those investors who have been long AMD as I have been the past 16 months have been a test of patience. But I strongly believe that now is the time to consider adding to my long position and an opportunity for investors to begin a position. The combination of AMD's chart and the potential positive catalyst that AMD's next earnings call may bring offer a great opportunity to add to or start a new position.

FreeStockCharts.com

Observing AMD's daily chart from 4/20/18 back to the end of 2016, we can see that AMD has been trading in a clearly defined range with the low around $9.30 to about $15.13 at the upper limit and defined by the magenta channel lines. It is a huge range percentage wise. Currently, AMD is around $10/share. There is support at the low range and there is psychological support at $10/share.

In addition to being at a supported level, we have, what I believe to be a positive catalyst arriving in the form of Q1 2018 earnings announcement on or around the 4/25/2018. I believe that earnings will be good. Save the debates for how good/bad the report will be for other articles.

How to take advantage

My strategy for taking advantage of this opportunity requires the use of options. For those not familiar, stock options are derivatives of the stock shares of a traded company and their values are tied to the movements both up and down of the underlying stock.

Below is the May 04, 2018 option tree for AMD as of market close 4/20/2018. I chose this expiration date because being an expiration date 7 trading days after the catalyst of Q1 earnings announcement, I anticipate this set of options to have good price movement and having sufficient time value which provides option premium advantage over using the current week's options for April 27.

The first step

The first strategy is the simplest. Purchasing a call option can provide a trader/investor with the ability to take advantage of the upward movement of the stock without the necessary capital outlay of purchasing the stock outright. For this example, I will purchase the $10 strike shown above for about $0.60 per contract. Since each contract represents 100 shares of the underlying AMD stock shares, the cost of the option is $60 (.60 x 100). For simplicity, we'll keep trade commissions out of the discussion.


If instead I had bought 100 shares of AMD stock, I would need to spend $1,000 (100 shares x $10 share). I do not want to commit and spend $1,000 yet ahead of AMD earnings. Buying the $10 strike call gives the owner of the call option the right to purchase the underlying stock at $10/share regardless of how high above the $10 strike price the underlying shares settle at market close on expiration date, May 04, 2018. The cost basis for the shares called away will be $10.60/share which is the sum of the cost of the 100 shares and the associated call option of $0.60. Above $10.60 are profits.

In this case, if AMD settles above $10, the call is considered in the money (ITM) and the shares will be assigned to the call owner at $10.00/share.
Alternatively, the call owner could sell the call option back to the market prior to the option's expiration date for a possible profit above $0.60 and not be assigned the shares. Thus, the term, option.

The risk to this strategy is that the call buyer risks $60 versus spending $1,000 and enduring the risk that between now and through expiration date May 04 that AMD shares drop in value. But here your risk is defined and static at $60.

But I consider the $0.60 per $10 call option a bit expensive and there is a way to build upon this example and reduce the cost of this trade.

The second step

My second idea for how to go further long AMD is to use a common strategy known as a call spread. A call spread is used to take advantage of potential upward movement in a stock price by purchasing a call option at one strike price and selling a higher strike price call to help pay or reduce the total cost of the trade.

For this instance, I would again suggest purchasing the $10 strike call for about $0.60 and sell the $12 strike call for about $0.10. The net effect in cost for the trade is $0.50 or ($0.60 paid - $0.10 sold). Because of the potential large upward movement of AMD's stock between now and the expiration date of 04 May, the $10 call option is a bit expensive and reflects the market's view of around a 6% upside movement prior to expiration. By selling the $12 call, I mitigate the overall cost of the trade by $10.

In this case, what happens at expiration date? If AMD settles at or above $10 on expiration date, the call option that we bought will be exercised and you will be purchasing 100 shares of AMD for $10/share at a cost basis of $10.50/share ($10/share + $0.50 net option cost). What happens if AMD settles at or above $12/share? Then the 100 shares assigned at $10/share are immediately called away at the $12 price level because the $12 call became ITM and whoever bought your $12 call option has the right to call away your newly acquired shares at $12 and paying you $12/share. Your profits are the $2 of share price movement from $10 to $12 minus the net cost of the options at $0.50 for a net of $1.50. That's a 15% gain.

The risk is that your profits would be capped at $12 if AMD stock shoots above that level versus our first scenario where we could continue to participate in upward movement but paying a bit more, $0.10, for the trade.

The other risk is that if AMD falls below the $10 strike upon expiration. If so, your loss would be $0.50 versus the $0.60 described in the first scenario.

A third step

So far, we've discussed purchasing a basic call option, continued with a basic call spread and now there is one more way to further reduce the net cost of the trade but there is some added risk by doing so.

This third strategy involves selling a cash covered put option at the $10 strike for about $0.56. What this means is that you cover the put option contract sold with cash, specifically, $1,000. The cash is set aside by your broker in the event that the put option settles ITM at or below the strike price of $10 upon expiration date of 04 May 2018. The $1,000 covers your assignment of 100 AMD shares at $10/share.

The owner of a put option has the right to put their shares to the seller at the option's strike price if the shares of the underlying stock settle at or below the option's strike price upon expiration date. For simplicity, the diagram below shows the effect of selling the put for $0.56 separately and not in combination with the first two described strategies. As we can see below, being assigned 100 shares of AMD at $10 and applying the discount of premium received ($0.56) by selling the put option reduces your cost basis to $9.44/share.

What happens if AMD settles above the $10 put strike at expiration? The put option would expire worthless, your $1,000 would be released by your broker and you can keep the $56 option premium (100 x $0.56) as profit.

What happens if AMD settles below the cost basis of $9.44? You'll be assigned 100 AMD shares at $10/share with your cost basis of $9.44/share. Below $9.44 you will be showing a loss by whatever price AMD shares are below the level shown by the red arrow in the above diagram.

By selling the $10 put in combination with the call spread strategy described, we can apply the put option premium towards our call spread cost of $0.50 as ($0.56 put premium - $0.50 call cost = $0.06). We are actually being paid a net $0.06 to perform this overall trade.

As great as that sounds, being paid to perform a trade, there is the added risk. The worst-case scenario is that upon expiration date, that AMD settles below $10. The $10 call purchased and the $12 call sold both expire worthless for a loss to you of $0.50. Additionally, the $10 put option is now ITM and because you set aside $1,000 to cover this put option, you will have 100 shares of AMD assigned to your account at $10/share regardless of how low the stock price is upon expiration. But remember that you were paid $0.56 for your put option sold. The put premium that you were paid reduces your cost basis of the shares by 5% to $9.44/share or ($10 - $0.56 = $9.44/share).

Selling the put option can be performed separately from the call option strategy that I described above or if combined with the purchase of a call option, it would be called a Synthetic Long Stock.

Personally, I prefer to purchase stock at a predetermined price by selling cash covered put options at strike prices where I am comfortable being assigned the stock and then selling covered call options to make predetermined sell levels as the stock rises. It is a disciplined manner by which to take profits, but as I described above, I run the risk of having my profits capped at $12. Experienced traders find it nearly impossible to time the top price of a stock, so I find it sound to pick my exit points without the emotion of the market.

Final thoughts

I strongly believe that AMD will not disappoint on earnings day. There are too many positive catalysts with regards to the company's improved product line, worldwide demand for processors, and opportunity to swipe market share from Intel (INTC) and Nvidia (NVDA).

The one thing that could place a bit of gasoline to the fire is the huge short position of 181,917,276 shares of AMD as of 3/29/2018. If AMD shows a positive earnings report along with positive guidance, the nearly 182 million shares will get squeezed hard when the short positions buy back shares to cover their positions. It will be fun to watch!

I hope that you enjoyed reading. I am aware that there are many different ways to get long AMD, but I wanted to offer a few basic strategies because of the unique opportunity. I encourage questions, and I will do my best to answer. Best of luck!

Disclosure: I am/we are long AMD, INTC, NVDA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Price chart courtesy of FreeStockCharts.com