Name That Trade – $SMH: Shake My Head

by Dan October 21, 2015 11:47 am • Commentary

Publicly trade tech companies (specifically those in the beleaguered PC supply chain) are in the midst merger frenzy.  There were two deals announced this morning for a combined $30 billion. In the semi-equipment space, Lam Research (LRCX) for KLA Tencor (KLAC). And in the storage space, Western Digital (WDC) for Sandisk (SNDK).  What’s fascinating about both deals is that they are being consummated at levels below the 52 week highs of the acquired, (SNDK $86.50 price vs $106.64 52 week high, and KLAC for $67 vs its 52 week high of $73).

What’s this telling me?? Both sides see the deal more as a necessity than from a position of strength. The lack of investor concern tells you that they are happy to have the premium. They’ll take the money.

But enough already. This is a total joke and unless we see an uptick soon in enterprise hardware and services demand, many of these deals will likely be completed at lower valuation levels or not done at all. It will be interesting to see if we get a mega-deal (one that would signal a top) like Intel (INTC) for Qualcomm (QCOM). That may be hard to do because om June 1st, INTC announced a $17 billion deal to buy Altera (ALTR) in an effort to diversify away from pc-centric chips.  QCOM would serve that purpose in a big way given their entrenched mobile chip business, but a company that size is probably too much to bite off for INTC at the moment.

Yesterday, some large opening put buying in the SMH, the Market Vectors Semiconductor etf, caught my eye. Total openings volume was 5x the average daily volume.  When the etf was $53.70 there was a buyer of 31,000 of the November 51 puts, paying about 63 cents, or about $1.9 million in premium.  These puts break-even in a month at $50.37, at the time of purchase, down 6% in a month.  Today the SMH is up 1.5%, and those puts are offered at 50 cents. The options market is suggesting they have less than a 19% probability of being in the money on November expiration.  This put purchase could be a short term hedge, as the news flow in the space (starting with INTC’s Q3 results and Q4 guidance last week) has not been atrocious and the merger frenzy shows no signs of abating anytime soon.  

Lastly I would add that the SMH just broke out above what was once important technical support at $54, and is above its 200 day moving average for the first time since early July:

[caption id="attachment_57848" align="aligncenter" width="600"]SMH 1yr chart from Bloomberg SMH 1yr chart from Bloomberg[/caption]

As would be expected with the market’s bounce this month, implied volatility in almost every sector has gotten squished off of multi-year highs achieved during the late August market swoon. I would expect short dated SMH IV to come in to 20% or possibly the high teens if there are no further earnings surprises in the coming weeks:

[caption id="attachment_57849" align="aligncenter" width="600"]SMH 1yr chart of 30 day at the money implied volatility from Bloomberg SMH 1yr chart of 30 day at the money implied volatility from Bloomberg[/caption]

To be fair I have been negative and wrong of late in the overall semi space. But I have been right on the continuation of the merger mania. The recent strength is almost entirely related to the m&a activity, but wrong is wrong and I am considering pulling the plug on my bearish INTC positioning from last week (read here).