The AI Party is in full swing at AMD.
With the tailwind of spending by large cloud customers (Amazon, Dell and Microsoft are among the largest), it is not surprising that AMD shares have more than doubled the performance of the S&P so far this year, up over 21% and ~80% over the past 52 weeks. Within the past couple weeks though some cracks emerged. AMD shares gapped to a new all-time high on March 8th before closing lower that day, a so-called “bearish reversal”. Is this a short-term setback or is there risk of further downside, and if so how might we use options to trade it?
Last December David McAfee, an AMD executive, described AI as transformational. It’s not hard to see why. Anyone experimenting with ChatGPT recognizes that Natural Language Processing (NLP) fundamentally changes how people interact with computers. Walking the streets of San Francisco, autonomous vehicles using AI are a common sight. SAG-AFTRA, the labor union that represents thousands in film and television including recording artists and actors just ratified new agreements with specific protections for voice actors over the use of AI. At the AI Safety Summit in the UK last November, Elon Musk said “…there will come a point where no job is needed…the AI will be able to do everything.”
With this backdrop, AMD CEO Dr. Lisa Su’s pronouncement a few months ago that the AI industry opportunity could reach $400 billion by 2027, while eye-popping, was entirely believable. More recently, at the Morgan Stanley Technology, Media and Telecom conference earlier this month, citing the pace of innovation in generative AI and increased Capex spending, she said that increasingly people are talking about $1 trillion in investment in AI infrastructure. Such is the feverish enthusiasm for AI that the size of the market and investments in it can rise by hundreds of billions in mere months.
While it is undoubtably true that the AI opportunity is enormous, are these increasingly fantastic pronouncements a sign that some of these stocks may be in frothy territory? AMD is now trading 50x full year estimated earnings and more than 11x full year revenues. These numbers could easily be justifiable if AMD’s revenues grew at the pace of Nvidia, which is forecast to grow revenues by 80% this year. However, AMD’s topline growth forecast is closer to 14%.
This type of fundamental analysis, while very important for long-term investing, generally does not provide a good trade-timing cue. There’s plenty of evidence that “expensive” or “cheap” companies from a fundamental point of view remain so for extended periods. Shorter term shifts in a stock price will more likely be propelled by shifts in sentiment or macro data points. This is precisely the kind of data analysis where AI can come in handy.
What the AI says.
iFi AI’s forecasts distill “hundreds of complex signals and millions of data points to make predictive forecasts” and the current 30 day forecast for AMD is lower. Bear in mind that the forecast for share price movement that iFi AI is calculating is based on probabilities, it isn’t a crystal ball.
An AMD options trade
Considering the heady valuation, the recent bearish reversal and the iFi forecast, a bearish trade makes sense, but shorting stocks carries unlimited risk. Using an options trade, we can limit our risk while using the forecast to identify the specific strategy.
Using the iFi forecast of 30 days as a starting point, I’ve selected the April 26th expiration date. One can purchase the April 26th weekly 180 strike puts for $10.15 and sell the April 26th weekly 167.5 strike puts at 4.75. I selected that 167.5 strike as that is the option strike closest to the iFi AI price target. A saying among options traders is that we want the price of the underlying stock to run through our long strikes and to our short strikes.
Between the 10.15 spent on the higher strike put, and the 4.75 collected by selling the lower strike put, the total net “debit” or cost of the trade is $5.40 per share ($540 in total, as each options contract represents 100 shares).
This trade risks ~3% of the cost of 100 shares of AMD and will see profits if AMD’s share price falls below the 180-strike put by at least the $5.40 spent on the trade by April 26th expiration. The break point in profitability is illustrated in the graphic below. The red region would see losses and the green region would see profits.
Michael Khouw
Michael Khouw, a 25+ year Wall Street veteran, is Co-Founder and Chief Strategist of OpenInterest.PRO, a financial data, analysis and investment strategy consulting firm. Mike is also the co-author of “The Options Edge” (Wiley, 2016) a comprehensive guide to understanding the value of options, optionality, volatility and strategy for both institutional and self-directed investors and an advisor to OptionsPlay, LLC a visual, intuitive and educational platform offering options analysis and trading support to institutional and individual options market traders.