In mid July, semiconductors as a group had a major technical breakout, with the SMH (the etf that tracks 25 semi stocks, Intel and Taiwan Semi making up about 30% of the weight) blowing through $60, the prior all time high from 13 months earlier:
Last night on CNBC’s Fast Money, my Options Action co-panelist , Carter Braxton Worth of Cornerstone Macro Research drew some lines on Nvidia (NVDA). NVDA is the 7th largest holding in the SMH at nearly 5%, but the best performing stock in the etf, up a whopping 105% ytd, and 170% from its 2016 lows. Carter thinks the stock has matched its measured moves, and no matter what your fundamental take on the company, the stock may in fact make higher highs. But his charting suggests that move will come from lower prices so patience is in order:
On Monday I had some thoughts on NVDA’s fundamentals (Graphic Novel), and concluded:
if you are kicking the tires now for NVDA’s opportunity away from gaming in AI, the ship has sailed. There are few who could, assuming anyone would (few expected Softabank as an entrant into the semi M&A space) pay 10x NVDA’s expected sales (close to $60 billion). Maybe 8x. Maybe. But if anything, with its stock where it is, and the strong balance sheet, NVDA is more likely to be an acquirer than an acquiree.
I highlight NVDA because it’s an example of a stock with a good story behind it, but also one where investors have gone off the rails.
Back to the semi space, they have benefited near term by better than expected seasonal demand for PCs (no one saw that coming, and a flurry of M&A resulting from PC & Smartphone chip makers attempting to diversify to emerging technologies:
Most of the M&A focus so far has centered around the Internet of Things (IoT). And the premium to sales have been massive, with INTC’s $17bn bid for ALTR last year,and ADI’s recent $15bn bid for LLTC, both about 10x trailing 12 month sales of about $1.5bn, only outdone by Softbank’s $32bn bid for ARMH at a whopping 22x sales!!
As we head into Q3 earnings in the coming weeks, PC and Smartphone component suppliers will be of particular interest as INTC has already pre-announced a better than expected Q3, and expectations are high for iPhone 7 units. I suspect barring more M&A it will take material beat and raises from the largest players in the group to keep the upward momentum intact.
So what’s the trade?
For those looking to target a 10% retracement back to the Sept lows near $63:
Trade: SMH ($69.25) Buy Nov 69 / 63 / 57 Put fly for 1.10
- Buy 1 Nov 69 put for 1.90
- Sell 2 Nov 63 puts at 45 cents each or 90 cents total
- Buy 1 Nov 57 put for 10 cents
Break-Even on Nov expiration:
Losses – of up to 1.10 between 67.90 and 69 & between 58.10 and 57, with max loss of 1.10 above 69 or below 57
Gains – of up to 4.90 between 67.90 and 63 with max gain of 4.90 at 63. Profits begin to trail off between 63 and 58.10.
Rationale – The SMH has gone parabolic on a move from 55 to 70 in a matter of months, largely the result of relentless m&a. If it is due for a pullback, then this put fly is a defined risk way to target near term technical support.