Broadcom Ltd (NASDAQ:AVGO) stock has had a good 52-week period, up over 50%. A big chunk of the rally came from last December. More recently and after a scare during the summer when it dipped 11%, AVGO is now back to consolidate just below this year’s high.
The daily price range is tightening, which indicates building energy that would need to resolve itself in a sizable move. If we are to assume that prices revert to the mean then AVGO move should be to the upside so that it reverts to its mean in the ascending regression channel. This assumes that the fundamentals remain favorable.
The long term weekly chart also shows that the weekly price range in AVGO stock is tightening. While this also supports the idea of an impending move, it doesn’t emphatically tell us the direction of it either.
Click to Enlarge My gut says it goes higher. Although I trust my gut, I need more than that to risk money on the direction. The weekly chart, unlike the daily, shows downside potential in AVGO if it were to revert to the mean. Luckily, even then the downside from that would be manageable but only if I use options.
If I buy AVGO in the open markets here I’d be risking $248 without any room for error. But by using options I can structure my trades to allow for a buffer just in case price goes against my gut.
The trick there is that I see support levels and more importantly is that I also see value. Against that I can sell downside risk and let time do the rest for me.
As far as value, AVGO doesn’t scream cheap, as it sells at a nearly 200 price-to-earnings ratio and negative margins. Compare that to Say Nvidia Corporation (NASDAQ:NVDA)’s P/E under 50.
Another point of worry is the expectation or exuberance that analysts currently have in AVGO stock. Their average price target is over $280 per share. This leaves a lot of room for potential downgrades there. Furthermore, nearly all the analysts have it as a buy, which also is a potential looming headline risk.
I would also like to note that AVGO stock is mostly in the hands of institutional investor so in theory, these are pros that won’t hit the sell button on a headline. They buy for a reason and they won’t sell until the fundamentals drastically strays from that reason.
AVGO Stock Trade Idea
The Trade: Sell AVGO Dec $185 naked put and collect $1.40 to open. This is a bullish trade which has a 90% theoretical odds of winning. But if the price falls below my strike then I must own the shares and suffer losses below $183.60.
To mitigate the risk that comes with selling naked puts I can sell a spread instead.
The Alternate Trade: Sell Dec $200/$195 AVGO credit put spread where I have about the same odds of success but with much less money at risk. Yet, if it wins, the spread will still deliver 10% in yield.
Since there are no guarantees when investing in the stock markets, I never bet 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 as @racernic on twitter and stocktwits.
