The devastation in semiconductor stocks on Friday into Monday was fairly staggering with the Philadelphia Semi Index (SOX) having declined 16% from the mid-September multi-year highs to yesterday’s close at the nice round number of 550:
The dramatic price action was caused by a warning by Microchip Systems (MCHP) on Thursday evening, and it caught investors off guard to say the least. The company suggested in a press release:
“We believe that another industry correction has begun and that this correction will be seen more broadly across the industry in the near future.”
Investors shot first and asked questions later, sending shares of large cap tech leaders like Intel (INTC) and Micron (MU) careening down 5%, losing billions of dollars in market cap (despite today’s 3% bounce in the SOX).
Well, to say that INTC’s Q3 report and Q4 guidance (tonight after the close) is important for semis and the tech sector as a whole would be an understatement given current market volatility. The options market is implying about a 6% one day move, which is slightly above both the 4 qtr avg of about 3.5%, and the 8 qtr avg of about 3.25%. The implied move is obviously a bit elevated as a result of options prices having gone from 52 week lows to multi-year highs in a month. INTC’s results and guidance have the potential to be impactful on the entire market in my opinion. A beat and raise could cause a rally back to the stock’s 50 day moving average around $34.20, while a miss and guide down could see the stock probe the gap level from mid June near $30.
As for trading INTC, the very near term set up is nothing short of treacherous and with options prices where they are, the margin for error on directional plays is tiny into the print. In an effort to broaden out the potential for a high probability trade around the event, I want to look at the Market Vectors Semiconductor etf (SMH) which tracks a group of 25 semi stocks, with INTC, TSM, ASML, TXN and MU comprising 50% of the etf’s weight:
What’s interesting is how hard hit these stocks have been hit in the last month (particularly the U.S. based ones): INTC down 9%, TSM down 4.5%, ASML down 8.5%, TXN down 13%, and MU down 20%
Three of the largest components of the SMH report this week: tonight we have INTC’s print, tomorrow morning ASML, and TSM on Thursday.
Much like INTC, SMH vol has blown out to multi-year highs:
A few trades we would consider depending on view:
For those playing for an out-sized move in either direction:
Buy SMH ($46.15) Oct 46/47 Strangle for 1.10
-Buy 1 Oct 46 put for .70
-Buy 1 Oct 47 Call for .40
Break-Even on Oct Expiration: Profits below $44.90 and above $48.10. Losses of up to $1.10 between $44.90 and $46 and between $47 and $48.10, with a max loss of $1.10 if the stock closes between $46 and $47 on expiration.
Rationale: Given the recent volatility combined with the possibility of extensive headline risk in the sector with the earnings reports this week, this trade is a way to play for more volatility for the next 3 trading days. On the flip side, the risk is that SMH stays within the $45 – $48 range this week, as it’s only a weekly straddle.
For those who who think Semis make a new low from yesterday and that the 3 components this week reporting serve as the catalysts:
Buy SMH ($46.15) Oct 46 / Nov 42 Diagonal Put Spread for .20
-Buy 1 Oct 46 put for .70
-Sell 1 Nov 42 put at .50
Break-Even on Oct expiration: This trade is different from the type of structure that we normally execute, as it will lose money if SMH ends on Friday around $46 or slightly above, but it will be a nice winner if SMH sells off below $45. The trade also does not lose as much as a normal put or put spread on a big rally since the Nov 42 put will lose some of its value as well. However, it’s a trade that needs short-term weakness to work.
This is a trade for those who want to play for a bounce in SMH:
Buy SMH ($46.15) Nov 47 / 51 Call Spread for 1.10
-Buy 1 Nov 47 Call for $1.30
-Sell 1 Nov 51 Call at $0.20
Break-Even on Oct Expiration: Profits of up to $2.90 between $48.10 and $51, max gain of $2.90 at $51 or above. Losses of up to $1.10 between $47 and $48.10, with a max loss of $1.10 if the stock is at $47 or below.
Rationale: November offers more time to play for a bounce back to near the highs of the year over the next 6 weeks. Implied volatility is elevated, but November options won’t decay too quickly for the next few weeks, so the directional move will be more important for the trade.
And finally, for those that think the implied vol spike is likely too much too soon following the recent selloff, an in the money fly makes sense. These strikes can be adjusted accordingly based on directional bias (with the center strike where you think the stock could end up)
Buy the SMH (46.15) Nov 50/45/40 Put fly for 2.00
– Buy 1 Nov 50 put for 4.20
– Sell 2 Nov 45 puts at 1.35 (2.60 total)
– Buy 1 Nov 40 put for .40
Break-Even on Nov Expiration: Profits of up to $3.00 between $48.00 and $42, max gain of $3 at $45. Losses of up to $2.00 between $48 and $50 or between $42 and $40, with a max loss of $2.00 if the stock is above $50 or below $40.
Rationale: This is essentially a vol sale with November vol at or above 30 going into these reports. If the etf was to stay within range that implied vol is likely to come in a bit next week. It’s probably not the trade for those looking to stick around until Novemeber with the market trading the way it is.