It was tough to watch Advanced Micro Devices, Inc. (NASDAQ:AMD) fall over 20% after the July earnings spike. But if you bought it 12 months ago then you’d still be sitting on profits from a 70%-plus rally. So as you can see, AMD stock qualifies as a momentum one.
These tend to be difficult to trade because on the way up, momentum stocks seem ready for a pullback, thereby causing buyers to hesitate. Conversely on the way down, few dare catch the proverbial falling knives. So traders are often left looking for the perfect entry point and those are rare.
Click to Enlarge There is a way around this. I use AMD options, where I can essentially bend time to virtually eliminate the need for surgically accurate timing. As long as I have a proper thesis and a set of levels, I can structure winning trades at any point.
Currently, I see technical upside potential in AMD. But I still won’t want to risk $12.95 to buy the shares and hope that it rallies. I require some room for error, and buying the stock leaves me none. Case in point, just a few days ago, it failed to breach the $12.70 per share area. It’s trying again but I want confirmation.
Also, while AMD stock is attempting a break out, it’s not doing it from higher lows. Instead it’s bouncing off a neckline area, which creates risk. If that neckline fails then it could invite incremental sellers from there.
Still, today I am betting that AMD stock is in the process of setting a quadruple bottom. Markets in general just shrugged off war headlines like they were nothing, so odds favor the bulls. Yet, and as noted earlier, I will still insist on a sizable room for error.
Notice that so far I’ve only noted technical stuff. That doesn’t mean that I don’t care about the fundamentals — to set my trades, I need solid fundamentals. While AMD is not cheap from a pure valuation perspective, I think it’s growing into its new normal. Our world is fast becoming completely digitized, and AMD is one of only a few suppliers to the brains of the tech, so in the long run it will thrive.
Often enough, expectations are as important as the results. AMD stock price is in the middle of the analysts price targets so there is no downside pressure there. Furthermore, the ratings are evenly spread across the gamete so the odds of surprise downgrades is muted.
AMD Stock Trade Idea
The Upside Potential: Buy the AMD Oct $13/$14 call spread for 35 cents to open. If the price rallies through my spread I stand to more than double my money. But I am not one to simply buy and hope things work out in my favor. So I will eliminate my cost completely thereby rendering this bet free.
The Bank: Sell the AMD Jan $10 put for 60 cents to open. This leg has an 80% theoretical chance to expire for maximum gains. Otherwise I lose money below $9.40. The net effect of taking both trades is a credit so I am getting paid to be long AMD. The only cost is the risk is owning AMD shares at $10 if it falls below it.
Taking both the upside potential and the bank trades means that I would be long AMD for free. As long as price stays above my sold puts, then any premium that I recoup from closing the call spread would be pure profit. Since my cost base is zero, even if I sell the calls for less than I paid I can still profit.
I can reduce the naked put risk by selling a spread instead. Then I’d be limiting the risk by the width of the spread.
The Safer Bank: Sell the AMD Jan $10/$9 bull put spread which will deliver over 25% in yield.
Investing is risky to I am cautious to never bet more than what I am able 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 @racernic on Twitter and Stocktwits.
