U.S. markets temporarily stumbled on a few headlines late last week, including the weakest retail reports since 2009. This was a shock to traders but the data is for December. These data are when we were at the worst sentiment period during the Christmas correction and government shutdown. So logic suggests that it would be temporary.
Then the markets took another leg lower on mixed news from the China/U.S. tariff talks. The knee-jerk reaction again was to sell stocks. But not all of them were falling. There were a handful of stocks that actually rallied during this red period of the day.
So when stocks rally in the face of major headwinds, it is a good indication that the rally would last especially when the headwinds disappear. In this case, my thesis is that these scary headlines will abate and that stocks, in general, will have a good quarter. So in this case, the safest upside bets would be those stocks that were green during last Thursday’s market dip.
Furthermore, most of them were sporting breakout potential from bullish chart patterns. This adds fuel to the fire and provides clear levels to trade. On that front, I don’t like buying based on pure hopeful speculation. I prefer to use options to sell risk below support and collect the premium. This way, I don’t even need a rally to win. All I need is to pick strong support levels and let time do the work for me.
The price action was bullish in three stocks I track, including Spotify (NASDAQ:SPOT), Micron (NASDAQ:MU) and Advanced Micro Devices (NASDAQ:AMD). Let’s take a closer look at a few ways to trade them:
Last week, Spotify showed great strength. I had been tracking its potential breakout from a bullish pattern. On Thursday, even though the markets were falling, Spotify stock was rallying. So that showed relative strength and I went long SPOT stock.
I sold a short-term credit put spreads for this week at $142/$141 for the opportunity to yield 13% in two days. I have a tight stop on that since there is little time to fix mistakes. But there are safer ways to trade this depending on portfolio balance and risk appetite. Traders are not all the same that way.
An alternative way to bet on the upside is to sell the March 22 $129/$128 credit put spread for similar metrics and yield. This can be modified wider or in distance to current price to suit risk tolerances.
Those who are willing and able to buy the shares can sell the Jul SPOT naked $105 put to collect over $3 in premium. If SPOT stock stays above my strike then I collect my maximum gains. But if it falls below it then I have to buy the shares at $105 per share. In that case, I would breakeven at $102.
I can buy temporary insurance by using what I call sacrifice puts. To guard against a crash, I buy April 105 puts for 60 cents. This way I am completely protected but only through mid-April. The same puts for March only cost 15 cents.
Last year when markets were reeling from negative sentiment, Micron was the whipping stock for traders. They shot it down all the way to sport a trailing 12 months price-earnings ratio of 2X! So, it basically fell to the floor. What a difference a few weeks make.
Year-to-date, MU stock is up roughly 30%. So clearly the bears had a change of heart. They forgot about the inventory and pricing fears that plagued the stock last year. I was lucky to sell puts into the stock at its worst but here I see more upside potential.
The fact that it spiked on Thursday morning when the markets were busy falling tells me that there is real money buying it with conviction. So I could buy the stock or debit calls or spreads to chase the move. Technically, traders could target the zone around $48 per share. But I prefer to sell risk below support and collect the premium rewards.
This is especially helpful since it just spiked almost 5% once already this week. Chasing here could mean I am late to the easy part of the rally. The options activity shows about 70% calls to 30% puts so all signs point up for MU stock.
I sold this week’s 41.5/41 credit put spread on a whim and when the VIX was spiking on the morning headline fears. But the easier trade would be to go out further in time and lower in price for a bigger buffer. March 8th $38.50/$38 credit put spread would also yield 30% on risk if MU closes above $38.50 by March 8. I can modify the placement and width to suit personal preferences.
Advanced Micro Devices (AMD)
AMD stock was the sherry stock of 2018. While the markets were setting a record in bad performance, AMD delivered a monster year. 2019 also started strong as it is now up 24% on the year.
So clearly the risk appetite for AMD stock is high. The CEO gets a lot of the credit as she has earned the respect of Wall Street. The consensus here is that AMD is the threat for Intel (NASDAQ:INTC) dominance for years to come.
I can profit from this exuberance without any out of pocket expense. For that, I sell AMD March 22nd $19.50/$18.50 credit put spread and collect the potential of 16% yield on risk. All I need is for AMD stock to stay above $19.50 for a few weeks. A shorter term version of this would be March 1 AMD $21/$20 credit put spread for the same metrics. They both have an 80% theoretical odds of success.
This, of course, will require the help of the general markets. And there is risk below since it’s rallied so far there are gaps that may need to fill. Nevertheless, I am confident that I can manage the risk even if I have to own the shares for a while.
Regardless of valuation, and it is expensive, investors want to own it here. This could change like what happened to Nvidia (NASDAQ:NVDA) but there are no signs of it yet.
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.