AMD Option: Buy At $66, Or Get Paid 10%+ In Q4
Summary
- AMD reported mixed Q3 results. It is scheduled to announce Q4 earnings results on Feb 7, 2023.
- A put option targeting its Q4 earnings date provides a 10%+ return in 95 days or the opportunity to buy the stock at ~$66.
- Such a play could be of interest to both swing traders and also long-term investors. An entry price of $67 is projected to deliver 12% to 17% annual returns.
- The Pensando acquisition, Xilinx integration, and CHIPS Act add further catalysts.
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Justin Sullivan
Q3 recap and Q4 preview
Advanced Micro Devices (NASDAQ:AMD) reported its Q3 earnings report (“ER”) earlier this month. And I am sure by this time, investors have already fully digested the details. Overall, the results are mixed with misses on both the top and bottom lines. Its EPS dialed in at $0.67, falling 3 cents (or 4.3%) short of consensus estimates. Total revenue came in at $5.57B, again narrowly missing consensus estimates (by $30M, or ~1% in relative terms).
More gloomily, the business is facing multiple headwinds, which are likely to persist into Q4 in my view. I anticipate the challenging macroeconomic times to continue (e.g., the PC market is likely to stay weak). And the company’s recent focus on its acquisitions (Pensando and Xilinx) will weigh on its bottom line in the near term. These factors have led to a rather pessimistic outlook as you can see from the following chart. Consensus estimates expect Q4 EPS at $0.68, essentially flat compared to its Q3 earnings and a sizable decline from an EPS of $0.73 it earned in the same quarter last year.
And this Q4 outlook leads me to the thesis of this article. In the remainder of this article, I will analyze the use of a put option targeting its Q4 earnings date. Due to a combination of the market’s concern over its Q4 ER and relatively high implied volatility, such an option play provides a 10%+ return in 95 days (more than 38% when annualized) or the opportunity to buy the stock at ~$67. And I will detail the implications of such a play for short-trading and long-term holding.
Source: www.marketbeat.com
AMD Q4 put option
AMD is scheduled to report its Q4 ER on Feb. 7, 2023. As a reference, it reported its Q3 results last year on 02/01/2022. Due to the concerns mentioned above, the options market is pricing its implied volatility (“IV”) around 55%. Admittedly, it is only at an average level compared to its recent record, as you can see from the following two charts below (its historical IV is shown by the orange line). However, when put under a broader perspective, such as IV is almost 2x higher than the overall market represented by the S&P 500 index (whose IV is currently about 24% as of this writing for the same time frame).
Source: IVolatility.com
And furthermore, such an IV is sufficient to provide a ~10% premium in 95 days. To wit, if you sell (i.e., write) a put option with a $75 strike price and expiration date of Feb 17, 2023 (shortly after Q4 ER), the premium is now $7.65, translating into 10.2% or 39% when annualized. So if the option expires on Feb 17, you could make 10.2% in one quarter, not a bad return for a swing trade.
If AMD price closes lower than $75 and the put is exercised, then you would buy the shares at $67.35 (= $75 - $7.65). Next, we will see the implication of a ~$67 entry price for long-term holding.
Source: oic.ivolatility.com
AMD: long-term return potential with $67 entry
As detailed in my blog article,
For a long-term investor, the return on investment (“ROI”) is simply the sum of two parts: the owner’s earning yield when we made the investment (“OEY”) and the long-term growth rate (“LTR”). That is:
Longer-Term ROI = OEY + LTR
Next, we will estimate both terms for AMD, starting with the LTR. The LTR is governed by two factors in turn - return on capital employed (“ROCE”) and reinvestment rate (“RR”). More specifically, LTR is simply the product of these two factors. AMD’s ROCE over the recent quarters is shown in the chart below. As seen, its ROCE was quite consistent, hovering between 30% to 40% since Q3 2021 with an average of 34.9%. Moreover, its MROCE (marginal return on capital employed) has been expanding rapidly, especially since it started integrating Xilinx. AMD’s MROCE has been 34% in the June quarter of 2022 and expanded to 43% in Q3. With such expanding MROCE, its ROCE should rise, and I anticipate it to be in the range of 45% given the ongoing progress of the Pensando and Xilinx integration (and also the CHIPS Act to be elaborated on next).
Source: author and Seeking Alpha.
Next, let’s examine its RR. The table below summarizes AMD's capital allocation in recent quarters. These results are shown in terms of the percentage of its main expenditures relative to its OPC (operating cash). As seen, its largest expenditure has been maintenance CAPEX, about 26.1% of its OPC. It does not pay a dividend. And it has been aggressively buying back its shares, spending about 20.7% of its OPC on average on share repurchases. All told, my estimate is that AMD has been maintaining a RR of 15% recently.
Source: author and Seeking Alpha.
With a 45% ROCE and 15.0% RR, AMD can maintain an LTR of 6.75% organically (45% ROCE * 15% RR = 6.75%). I consider my above estimate to be on the conservative side. As you can see from the following chart, the consensus estimates are projecting its EPS to grow from $3.5 in 2022 to $6.58 in 2023, implying a CAGR of 13.5%. A main catalyst could be the CHIPS Act. My above estimate of its RR being 15% recently did not factor in the CHIPS Act. Looking forward, the CHIPS Act could effectively boost its RR (either directly or indirectly) via R&D tax credits, sponsored research, and also subsidies.
Source: author and Seeking Alpha data.
AMD’s OEY at $67 entry
Now, let’s analyze the OEY at a $67 entry. Here, I will approximate its owners' earnings by its EPS (which puts my estimates on the conservative side). At its 2022 consensus estimate EPS of $3.5 as shown above, its current price corresponds to a PE of 20.68x. But at a $67 entry price, the PE would be only ~19.1x, leading to an OEY of ~5.2% ($3.5/$67 = 5.2%).
With this, the next chart below shows my return projections combining the LTR and OEY. The key observations are:
- At its historical RR level of 15%, the total annual return potential would be ~12%, consisting of 6.75% of long-term growth and 5.2% OEY as analyzed above.
- In the case of a boosted RR from the CHIPS Act to, say, 25%, the total annual return potential could be above 16% as seen due to a higher LTR (the OEY would remain the same at 5.2%).
Source: author and Seeking Alpha data.
Risks and final thoughts
To recap, AMD is facing several headwinds ahead. I anticipate the macroeconomic environments (inflation and recession uncertainties) to remain challenging in the near term. The global PC demand is likely to stay softened too. Specific to AMD, its acquisitions of Pensando and Xilinx will keep pressuring its bottom, and full integration will take some time to complete.
Also, for investors new to options, I want to emphasize their own risks:
- At least in theory, there is always a risk that the stock price goes to zero, but you still have to buy the shares at $75 if you write puts on AMD.
- Also, the writing strategy I mentioned here is based on the assumption that you write COVERED options. If you write uncovered (aka naked) options, then your risk/return calculus would change depending on the specific terms of trades (like the margin rates et al).
To close, the market’s concern about AMD’s Q4 uncertainties has created an attractive option play. Its IV is currently around 55% for NTM (near-the-money) put option with Feb 17, 2023 expiry. In the case of expiration, such IV is sufficiently high to provide a 10% premium in one quarter, translation into about 39% when annualized. In the case of exercising it, option writer gets to buy AMD at $67, an attractive entry price for long-term holding in my view.
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This article was written by
** Disclosure: I am associated with Sensor Unlimited.
** Master of Science, 2004, Stanford University, Stanford, CA
Department of Management Science and Engineering, with concentration in quantitative investment
** PhD, 2006, Stanford University, Stanford, CA
Department of Mechanical Engineering, with concentration in advanced and renewable energy solutions
** 15 years of investment management experiences
Since 2006, have been actively analyzing stocks and the overall market, managing various portfolios and accounts and providing investment counseling to many relatives and friends.
** Diverse background and holistic approach
Combined with Sensor Unlimited, we provide more than 3 decades of hands-on experience in high-tech R&D and consulting, housing market, credit market, and actual portfolio management. We monitor several asset classes for tactical opportunities. Examples include less-covered stocks ideas (such as our past holdings like CRUS and FL), the credit and REIT market, short-term and long-term bond trade opportunities, and gold-silver trade opportunities.
I also take a holistic view and watch out on aspects (both dangers and opportunities) often neglected – such as tax considerations (always a large chunk of return), fitness with the rest of holdings (no holding is good or bad until it is examined under the context of what we already hold), and allocation across asset classes.
Above all, like many SA readers and writers, I am a curious investor – I look forward to constantly learn, re-learn, and de-learn with this wonderful community.
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.