Advanced Micro Devices, Inc. (NASDAQ:AMD) reported last night, and Wall Street absolutely hated the results, especially the guidance. The stock fell to $12.50 in after-hours trading. This morning and after a few hours of investors chewing on the report, AMD has recovered some but is still down 10%.
Luckily, coming into the event, AMD stock was up 25% year-to-date and up 110% in the past 12 months. So, it’s safe to say that AMD is a momentum stock. These are stocks that move fast and long like Amazon.com, Inc. (NASDAQ:AMZN). They are great when they are rallying. But on bad days, they appear to be falling into an abyss.
Click to Enlarge When momentum stocks fall they are the scariest knives to catch. But by using options I can slow them down for a chance at free profits. Timing is critical. I don’t want to take a position too early then find myself on the wrong side of the trade quickly. To deal with the timing issue, I will use options to trade AMD stock today.
Today and on this move, I want to sell downside risk against what Wall Street fears. This is something that I’ve done several times this year. It will continue to work for as long as the uber-bulls are in charge of the stock market.
Fundamentally, I can’t argue for value since there is none tangible. AMD runs in the red. Its price-to-book is over 30. Compare this to say Intel Corporation (NASDAQ:INTC) which has a price to book under three.
Clearly today my bet is based on price action rather than value. I am taking risk based on the fact that equity markets are bullish and that buyers will step into AMD stock on this dip.
Coming into the earnings event, AMD stock was looking technically frisky. It was attacking a neckline from higher lows and had they breached it, the bulls could have retested $15 per share. Instead, the price action is now unfolding in the opposite direction. Based on the open interest, $12.60 was the first line of defense. From here, onus is on the bulls to prove that they are brave enough to buy.
Opinions do matter and analysts had been in a holding pattern. Yesterday, AMD stock was trading exactly in the middle of their price target range. Today, it has more upside than downside potential inside that range. However, experts do change their minds, and I have to make room for the possibility of downgrades.
So, I won’t be buying the shares outright in the open market. Else I would have no room for error. Instead, I will use the AMD options so I can build a moat around my risk just in case there are more sellers this week.
AMD Stock Trade Idea
The Trade: Sell the AMD Apr 2018 $10 naked put and collect 50 cents per contract. Here I have an 80% theoretical chance of winning. But if the price falls below my strike, then I would accrue losses below $9.50.
Selling naked puts carries big risk. In my case, I don’t mind owning AMD shares. But for those who want to mitigate it, they can sell a spread instead.
The Alternate Trade: Sell the AMD Apr 2018 $10/$8 bull put spread where I have about the same odds of success. But here the spread would yield 17% on risk. In either case, I don’t need a rally to win. What’s important is for AMD to stabilize at or above my strike.
Ultimately, regardless of how careful I am, investing in stocks is fraught with danger, so I never risk more than I am willing to lose
Get my newsletter for free 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.