Last month, Subscribers to Schaeffer's Event Trader service just scored a 201% profit in just under a month with semiconductor stalwart Advanced Micro Devices Inc (NASDAQ:AMD) June 18, 2021 72.50-strike call. Below, Schaeffer's Senior Market Strategist Chris Prybal hopped on the Market Mashup podcast to unpack the trade, detail why we were bullish on the chip stock, and offer some insight into how he looks for big winners. Below is an excerpt of the episode.
Patrick: You entered the June 72.50 call on Monday, May 17. What were some of the drivers that you saw, leading up to the trade?
Chris: Broadly, and from a global perspective, the trade war with China has pretty much heightened the fact that we get the majority of our chips, and the processing is done overseas in Taiwan. The U.S. does not manufacture many chips here anymore. Everything you buy, from a video game to a kid's toy to an automobile, has multiple chips, I read an article that car these days where a truck has 1400 separate chips just to produce one vehicle.
Our economy is tied to the semiconductor industry. And since the trade war with China, it's become evident that America needs to manufacture and produce chips in house in country so that our supply chains are equipped at all times. And we're not reliant on foreign power or an adversary that could come in and take out our manufacturing capabilities and then pretty much wipe out our supply chain.
Over the past year, there's been an increase in mergers and acquisitions (M&A) activity within this space. The numbers I saw was as high as $118 billion just in M&A activity last year, a lot of these types of combinations are still in courts. They're awaiting approval, but all intentions point to the three in question. And Nvidia (NVDA) is buying ARM. So, it's an American company buying a European company. You got Analog Devices (ADI) buying Maxim integrated. Both of those are American companies. And then AMD was in the midst of buying Xilinx when I put on this trade. There's vast amount of tying up for protectionism. And for manufacturing purposes, we need to do these things in house.
When they announced the merger, the combined value of the company was set at $135 billion. Now it was going to take nine to 12 months for the approvals to go through. There is always a lull period with these M&A's where the stocks do not advance. They lose the market because they consolidate, because there's uncertainties around mergers, they could get postponed, that could get delayed, they could get eliminated altogether for security concerns. There's a lot of hesitancy amongst investors on whether or not to step in, but I went ahead and stepped in, because at the time of the first trade here, the market value of AMD, and Xilinx, if you put the two together, it had fallen well below that $135 billion, and it fell down to $120 billion, per the chart below.
You can see that that around $117 billion, it seemed to be a floor. And I was thinking '$121, $117, they're pretty close', knowing that combined value on announcement day was $135. But I took a stab from a valuation point of view and got our subscribers into the trade knowing I just had a gut feeling that it would go through for the security concerns, and American needs to consolidate these industries for strength and power.
I thought it was a value for our subscribers. Subsequently, the sentiment factor was pretty favorable, you have pretty low implied volatility (IV), which is a crucial component of any option buyer. There were 14 hold ratings and one sell one strong sell on an uptrending stock; AMD, over a 10 year period, was up almost 1,000%. And it had pulled back at that time to 750%.
It's market value was $90 billion at the time, so, you had a good Expectational Analysis set up which we harbor here at Schaeffer's, which combines fundamental technical and sentiment analysis into one package. I was very lucky that two days after initiation of this trade, AMD came out and said they were going to initiate a $4 billion share repurchase program, which $4 billion divided by 95% of the value of the outstanding they were going to purchase back and that started to move the shares higher in earnest, allowing our subscribers to have some profit that day.
Patrick: You also mentioned how short interest had double I think since the merger, was that something that you were also looking at as a possible driver?
Chris: You'll see sometimes when you have M&A activity, there's an arbitrage related trade. With that said, we have other indicators that dissect whether or not it's arbitrage related in that particular indicator was still rather high, suggesting that there was a lot of daily short interest and shorts that were specialized on maybe the merger, not working out. Whereas once they got approval from the European Union (EU), the stock spiked because there's less uncertainty that ultimately will work up.
There's a lot of connective tissue between your GameStop (GME) trade and this one with how you monitor macro news headlines, EU approvals, same-store sales back with the GameStop. You are balancing a lot of the technical analysis that we do at Schaefer's with the macro headlines. Is that something that comes natural to you? Why do you gravitate to that sort of research?
Price is what you pay, but value is what you get. A lot of times stories of being missed by the media because they want clicks, eyeballs, and what's popular. But if you dig into the details, you'll discover and uncover things that other people missed. And they may or may not pay off for you right away. But to keep uncovering these truths about a stock or sector, that really makes you feel empowered, that you discovered things before other people. And then you watch the public come in, and start to buy up what you're in. It allows you naturally to sell easier; you're not a forced seller, there's plenty of people to sell to, because you were into that trade before.
Patrick: Are you still eyeing the chip sector? What's next for a stock like AMD?
Chris: Well, the buyback was well-received, I think that was a sign from management. The company's financially secure, and they've made it clear that they think this merger will be completed by the end of the year. AMD went up, obviously, to get to 200%. But then it kind of consolidated for a bit. And it pulled back to short term moving averages. Sentiment really has not changed, because Wall Street is still worried about whether China will approve this deal.
And then ultimately, will the United States approve the deal? I think once you see that those two bodies approve it, the full value of this merger will begin to be shown. And I believe you'll be handsomely rewarded if you allow yourself enough time because there is the caveat of the trade war. And that's the beauty of options, it's in your terms; you set your cost of entry. And then you factor the time component, and how it manages the risk of your capital.
Subscribers to Bernie Schaeffer's Chart of the Week received this commentary on Sunday, July 18.