China Selloff Sets Up Applied Materials, Inc. Bulls for a 200% Return


A knee-jerk reaction to news out of China yesterday has the semiconductor sector reeling. But this selloff is overdone, leaving plenty of opportunities. Among the biggest bullish opportunities right now lies with Applied Materials, Inc. (NASDAQ:AMAT).

Let’s deal with the China story first. With the threat of a trade war with the U.S. brewing, Chinese officials set forth a plan to boost domestic semiconductor production. In fact, China made chip development a key component to its Made in China 2025 initiative.

The problem is that Chinese semiconductor firms are far behind their competitors in the U.S., Japan and Europe. In other words, competition from Chinese chip makers isn’t coming anytime soon, making yesterday’s selloff rather premature.

As a result of the market’s overzealous treatment of semiconductor stocks on Thursday, AMAT stock plunged nearly 6.5%. The shares are now down more than 18% from their March 12 peak near $61, placing AMAT stock near oversold levels.

AMAT Stock
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The shares are also hovering near their 200-day moving average, having breached their 50-day in Wednesday’s session. As a result, AMAT shares are now nearing key psychological and technical price support near $50. With an industry lagging P/E ratio of just 19.27, AMAT stock is sure to rebound from current levels quickly.

The good news for Applied Materials bulls is that a catalyst lies just over the horizon. The company will report first-quarter earnings in mid-May. The date isn’t set, but estimates place the report near May 16, about four weeks away.

Analysts are expecting Applied Materials earnings to soar 44% year-over-year to $1.14 per share. Revenue is expected to rise 25.5% to $4.45 billion. That’s some solid growth, and given its firm position in the market, it will be quite some time before Chinese companies threaten market share. Look for guidance to be positive and AMAT stock to rise as a result.

Aside from the negative Chinese headlines, sentiment toward AMAT stock is quite bullish. For instance, Thomson/First Call reports that 20 of the 21 analysts following the shares rate them a “buy” or better, with one lone “hold” rating outstanding. What’s more, it is currently trading well below the consensus 12-month price target of $70.24, leaving plenty of room to run before valuation becomes a concern.

AMAT options traders are also quite bullish. At last check, the May put/call open interest ratio came in at 0.57, with calls nearly doubling puts among options potentially most affected by earnings. Peak call OI for the series totals 5,100 contracts a the overhead $55 strike.

Overall, May implieds are pricing in a potential post-earnings move of about 7.75% for AMAT stock.  This places the upper bound near $55.15 and the lower bound near $47.20.

2 Trades for AMAT Stock

Call Spread: Barring geopolitical factors, AMAT stock is at a greate entry point for a long position heading into earnings. The shares are oversold and trading at a significant discount to their peers and analyst expectations. As a result, the rally could be much bigger than May options are pricing in.

Traders looking to profit from this situation might want to consider a May $55/$57.50 bull call spread. At last check, this spread was offered at 57 cents, or $57 per pair of contracts. Breakeven lies at $55.57, while a maximum profit of $1.93, or $193 per pair of contracts — a potential 230% return — is possible if AMAT stock closes at or above $57.50 when May options expire.

Put Sell: The problem with betting on a bullish earnings reaction right now is that Applied Materials hasn’t officially set a date. If it happens to be after May options expire, it would negatively impact the above trade idea. For those looking for a more cautious approach, a May $45 put sell is a viable alternative.

At last check, this put was bid at 55 cents, or $55 per contract. If AMAT stock trades above $45 through expiration, traders entering this position will retain the premium received. However, if AMAT stock trades below $45 ahead of expiration, then traders may be assigned 100 shares at a price of $45 per share for every contract sold.

As of this writing, Joseph Hargett did not hold a position in any of the aforementioned securities.

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