If I were to say I was placing ‘a chip on red’ you might think I was wagering on roulette. You’d also be incorrect.
What I’m referring to is a smarter, modified, but still quite simple, butterfly spread betting that when chip giant Intel Corporation (NASDAQ:INTC) reports earnings next week, Intel stock will sink deeper in the red.
Intel stock has gone out of favor in recent months. Compared to the PowerShares QQQ Trust, Series 1 (ETF) (NASDAQ:QQQ) and first quarter gain of 2.5%, INTC shares have slumped about 14% during the period.
A report of low Windows Pro revenues for Microsoft Corporation (NASDAQ:MSFT), coupled with Intel’s own sales warning last month tied to weak PC demand, as well as related investor concern that the company is failing to capitalize on the mobile device market, have largely supported the pressure in Intel stock.
INTC Technical Picture
Aside from peeling off more than a dozen percentage points from multiyear highs, 2015’s price action in Intel stock has technically set up a bearish weekly head and shoulders top with confirming MACD divergence.
Viewed on the weekly chart, INTC stock’s left shoulder and higher head developed while the moving average convergence divergence (MACD) moved negatively lower. Currently, a flawed, slouching right shoulder is building in Intel stock. The 50-week moving average at $32.59 and modestly higher weekly pivot high of $33, act as pattern resistance.
INTC Options
The problem with positioning in INTC shares bearishly or as a bull for that matter, is Intel is slated to report earnings after the market close on April 14. While Intel stock isn’t known for aggressive post-earnings movement, there is always the risk of an undesired gap causing a larger-than-expected loss.
On the other hand, INTC option traders have the ability to position directionally with limited risk. However, with Intel implieds in the $30s, simply buying a long put, if a bear, is pricey statistically. As we close in on earnings, INTC options have been bid higher.
What’s more, those premiums are likely to evaporate after the event. That’s true regardless of Intel stock’s price direction and due to an expected ‘volatility crush’ typical of option prices following an earnings announcement.
This all said, one attractive-looking way to position bearishly in Intel stock with limited risk and slightly more effective use of premiums than a simple bear vertical is a modified long butterfly in INTC. This is accomplished by centering the Intel option spread below the current Intel stock price and using verticals of different widths. Let me explain.
INTC Trades: A Modified Butterfly
A regular long butterfly position consists of two verticals sharing the same short strike and using either all calls or all puts. This means one vertical spread will be bullish and the other bearish. Additionally, the purchased spread will cost more than the credit associated with the sold vertical.
In Intel stock, because we’re bearish, the INTC out-of-money puts make sense as they’re typically easier to trade.
Using puts, a long Intel butterfly is constructed with the bear vertical using the highest purchased strike. The lower sold strike is shared i.e. ‘the middle’, with the sold bull vertical’s higher short strike. Finally, the INTC bull put vertical’s lower strike is purchased, which of course is what creates the limited risk profile.
Long butterflies are enticingly cheap spreads when one looks at the risk, i.e. net debit, compared to the potential reward. Take a look at Intel stock’s listed INTC options and you’ll quickly realize this. The problem with regular butterflies is because of the competing, same width verticals used, they’re typically slow to realize profits.
Complicating matters, maximizing profit would require pinpoint precision with Intel stock landing squarely on the strike of the two sold contracts exactly at the closing bell on expiration! What’s more, if INTC shares happen to overshoot the spread on the downside, the regular butterfly would realize its maximum loss or the debit paid.
INTC April Modified Bear Butterfly
To get around most of these issues, a bearish modified long butterfly in Intel stock can be considered. With shares of INTC near $31 at last check, the Apr $31/$29/$28 combination fetches 48 cents. This compares to 85 cents for an outright Apr $31 put and 61 cents for the Apr $31/$29 bear put spread. The shown risk graph is sized at five contracts.
Overall, INTC’s modified fly price fits in well with what’s been laid out regarding our opinion on Intel stock and typical post earnings movement that’s averaged out to about 3% the last five reports and a range of 0.60% to 9.27%. If INTC shares manage another average result to the downside, the spread is pennies away from maximizing its $1.52 profit potential.
Were Intel stock to overshoot the lowest purchased INTC Apr $28 strike with an outsized result like 9% to the downside; unlike a regular fly the trader remains profitable and would take in 52 cents at expiration. This is due to the sold bull vertical component’s strike width of one point and associated $1 loss, being smaller than the $2 captured by the bear vertical minus the spread’s initial debit.
The information offered is based upon Christopher Tyler’s observations and strictly intended for educational purposes only; the use of which is the responsibility of the individual. As of this writing, he held no positions in any of the aforementioned securities in his personal or managed family accounts but may initiate, for better or worse, a position in two or more business days following the publication of this article.
