The semiconductor stocks have been a focus for us over the past few weeks as it seemed the entire space, and particularly some components of the SMH had gotten a little ahead of themselves in 2018. We recently updated our trade idea in SMH (here) and now I wanted to check back in on one of the top 10 holdings in SMH, Micron (MU). Here’s what we had to say about the stock into its March 22nd earnings event. From March 21st:
Does the stock’s more than 100% gains over the last year adequately discount a bit of good news? Your guess is as good as mine, but at the first sign of a meaningful deceleration in sales growth, and you have a situation where both investors and analysts are all on the same side of the boat.
Micron actually beat on earnings but the stock still got hit. That reaction was one of our inputs in looking at the entire sector through the SMH trade the next day. But back to Micron itself, we detailed two trade ideas, one was a very short term outright bearish that worked out nearly perfectly:
Outright Bearish:
MU ($61) Buy March 23rd weekly 60/55/50 put butterfly for $1
That trade targeted 55 and tried to reduce premium risk as much as possible through a butterfly. It worked out great as the stock closed 54.21 and the put fly worth 4.21 versus the $1 initially at risk.
But turning to the hedge for those long the stock, we took a longer view on that idea to capture any sustained selling after the event itself, here was that overlay:
Hedge vs 100 shares MU long at $61
Buy the May 57.50 / 50 Put Spread vs selling May 70 call for even money
-Sell to open 1 May 70 call at 2.25
-Buy to open 1 May 57.50 put for 3.45
-Sell to open 1 May 50 put at 1.20
At the time the stock was 61. MU has been under a lot of pressure since and is now 48.60. That means this hedge worked out about as well as it could have worked out. Initially put on for even money, it is now worth 5.30 taking away big part of the sting of this selloff. Obviously, it can be worth up to 7.50 at expiration (the difference between the strikes on the put spread) so it could help a little more if the stock goes lower (or stays here). But the protection maxes out at 7.50, so if you were worried about further downside (for instance, below 40) you may want to look farther out for a roll into the Summer that protects below 45, perhaps the July 45/40 put spread.
For those looking to book this hedge soon and play for a rebound, one way to do that is with a ratio call spread. Right now the May 50/55 1×2 call spread costs about .30. What that means is if MU were to bounce between now and May it would be like owning 2x the stock (assuming 1 to 100 shares) between 50.30 and 55. If the stock were to bounce back above 55 you are called away in the stock, but at an effective sale price of 59.70. That’s pretty close to to where the initial hedge was initiated. And the amazing thing is if the stock were to bounce back to 55, between booking $5.30 on the hedge then the opportunity to add up to 4.70 on a bounce, It would be as if you added $10 in profits in the stock.
Obviously, there’s no indication that the stock will bounce anytime soon, it could keep going lower, but the hedge took on some of those losses. And just as we looked down with the hedge when the stock was near its highs, we like to look up after the decline, and a ratio call spread like this in one way to do that, while only risking .30 if the stock continues lower (or goes nowhere).