Advanced Micro Devices, Inc. (NASDAQ:AMD) has recently had a mini correction. But that was a partial giveback from an even bigger rally. So it’s safe to say that AMD is a momentum stock which has been on a tear in the past 12 months.
The problem with momentum stocks is that they often cripple investors. On the way up, they rally so fast that they constantly appear due for a pullback. Then when they dip, they seem like falling machetes. That’s why I strictly use options to trade AMD stock.
I’d like to say that this drop in AMD is deep enough that the weak hands are all out and that I can safely go long … but it’s not likely true. Price is still well over 100% higher than 12 months ago levels. But when I see a price differential this big, I assume that the lows were absolutely wrong and they are not likely to come back.
Even then, this alone is not a reason to chase upside performance. Because just like the lows were wrong, I assume that the extreme highs were also wrong. Somewhere in the middle lies the truth.
So instead of chasing higher prices, I will use options. There I don’t have to risk $12 with no buffer. I can generate income with healthy margins for error. The trick is to find support levels that are likely to hold.
Fundamentally, AMD stock is not cheap, so I won’t try to argue from that angle. The saving grace is that analyst expectations are somewhat realistic. On average, analysts have it as a hold. This usually reduces the chances of surprise downgrades and leaves the door open for upgrade surprises.
We know that the stock market prices in future prospects, not current valuations. That’s probably why Advanced Micro Devices is catching a bid. We live in a world that is becoming more dependent on technology than ever. And with as few suppliers to our techs as we have, they are all likely to thrive. AMD is one of those companies.
Click to Enlarge Technically there are worries. What was support in early 2017 has now become forward resistance. AMD stock bounced off the $12.50 area as support until May when it fell off a cliff. Since then the stock has failed to regain that level.
Since the upside potential looks labored at this time, I will not buy AMD stock at face value and hope it rallies. While I remain optimistic that the dips will be bought, I am less confident that bulls can remount the rally. So, I will use options to implement my thesis. And if by chance the stock falls another 20%, I will be willing to buy it.
AMD Stock Trade Idea
The Bet: Sell the AMD Oct $9 put for 70 cents or better, where I have an 80% chance of success. But if AMD falls below $9 per share I will then own the shares and risk accruing losses below $8.30. This gives me a 20% buffer, with which I am comfortable that I will be able to manage my risk short-term against price gyrations.
Not everyone is willing to sell naked puts. For those people, I can suggest spreads instead.
The Alternate Bet: Sell the AMD Oct $9/$8 credit put spread where I have about the same odds of success but with limited risk. The spread would still deliver a respectable 25% in yield.
Selling options is risky business, so I never risk more than I am willing to lose.
Learn how to generate income from options here. Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him on Twitter at @racernic and stocktwits at @racernic.
