Semiconductor companies are up big today in the stock market… led by NVIDIA Corp (NVDA)’s 5.6% midday gain, Micron Tech’s 5%, AMD’s 4.4% and Intel’s 2.6%. These large gains are being driven seemingly solely due to positive news from the U.S.-China trade war.
Presidents Trump and Xi agreed to meet face-to-face in Osaka, Japan during the upcoming G20 meeting at the end of the month. The two, as the market hopes, could come up with some kind of ceasefire in their trade war.
This would be enormous for the heavily effected semiconductor industry, which relies on supply partnerships between the two economic giants.
Of course, it would be silly to place any kind of bet right now that a trade deal will or will not happen. With how this long negotiation process has gone so far, the two sides are just as likely to make things worse than they are to make them better.
Instead, there’s another important reason to take a look at semiconductor companies right now. They are trading like no one has a clue what’s going on.
Here we have the iShares PHLX Semiconductor ETF (black line), which holds all the giants mentioned up top and the S&P 500 (gold). As you can see, this group of semiconductor stocks have been way more volatile than the market as a whole, with much lower lows and much higher highs.
This year began with a wild and historic four-month rally in the industry. After the weak fourth quarter across the market, investors grew optimistic about PC and gaming sales – big drivers of the industry. Those hopes were dashed with absolutely terrible first quarter numbers across the board.
The worse was NVIDIA, the leader in graphics cards in gaming. Consumers just aren’t buying new rigs. Revenue during its first quarter was slashed by 31% year over year. Obviously, this had a major impact on its share price.
Investors fled NVDA shares in May. But with the recent mini rally in the overall stock market, they seem to be trickling back into the company.
This wild ride isn’t the first in recent memory for NVDA investors. Here you can see the last two years of price action:
The interesting thing to note is that after all of this – the Mt. Everest-sized climb and then avalanche – has left shares exactly, almost to the penny, where they were this time two years ago. Of course, a lot can happen in two years… especially for a tech company.
In that time, revenue has gone up a ton – from $6.9 billion to $11.7 billion annually. Even this most recent quarter, which has investors running scared was much more successful than the first quarter two years ago, with sales up 14.6%
This growth despite no appreciation by investors, was driven by innovation and product launches. The company’s crowning achievement during this period was the launch of the GeForce GTX 1080 Ti graphics card.
NVIDIA might not be seeing the kind of sales it did when that first came out, but the company hasn’t been idle. In fact, the very thing that makes NVIDIA so appealing – at least from a long-term perspective – has nothing to do with graphics cards or gaming.
NVIDIA is the leading developer of artificial intelligence. Just this week, the company announced the unveiling of its DGX SuperPOD supercomputer. According to the company, this system’s setup time is about three weeks. Competing systems take six to nine months. And it’s powerful… able to run a leading AI training model within two minutes compared to 25 days previously.
This segment of NVIDIA doesn’t get the kind of credit it deserves. Right now, it isn’t a moneymaker. But that’s only because these are the first steps of a giant industry of its own.
We’ve all seen headlines about autonomous cars being the future. Well, it’s not far off. Some are already on the road… with another 10 million by 2020 according to Business Insider. If NVIDIA gets the piece of that it should, that’s a gamechanger. And it will.
Already, the company has partnered with Toyota – the world’s largest carmaker – and Volvo for autonomous trucks. While these sales may seem slow in coming, they are going to start making a greater impact in upcoming quarters. And as summer drags on, and we near NVIDIA’s next earnings, investors are going to start paying attention.
This presents us with a tremendous opportunity. In fact, because of timing, we could see a near perfect situation develop.
First, let’s look at the type of trade that’s triggering…
A Strategy For Short Term Bulls
A bull call spread is a type of options trade that involves buying a call option on a stock you believe will go up in price – like NVDA – a selling a second call on it with the same expiration date but a higher strike price.
This helps offset the cost of the first, which lowers the amount at risk. That amount, the cost is all investors stand to lose during the full duration of the trade.
In exchange, the maximum profit potential is capped. But for certain trades – like the one developing in NVDA – that’s well worth it.
You can see what this kind of trade looks like here:
Source: The Options Industry Council
As you can see, the trade grows more profitable as share prices rise, up to that upper strike price. But just as important to this kind of trade is timing.
Let’s look at the specific situation developing in NVDA…
A Specific Trade on NVDA
Right now, a trader could buy an August 16 $155 call for $9.80 per share and sell an August 16 $165 call for $5.85 per share for a total cost of $3.95 per share. Since each option is worth 100 shares, that’s a net debit of $395.
That’s the most the trader stands to lose on this trade. The maximum profit is much larger. To find that, take the difference in strike prices ($165 – $155 = $10), and subtract the cost ($10 – $3.95 = $6.05). That means for a cost of $395, this trader would stand to make $605… or 153% return on his risk.
Shares do have to jump to $165 to lock in this full return. But that’s where this timing factor comes into play.
Notice the expiration dates for this trade, August 16. That’s the day after NVIDIA’s next earnings announcement. With so few investors excited about the company right now, it won’t take much to surprise them.
Sometimes, the best way to play a terrible quarter is to invest before the next one. For NVIDIA right now, that’s exactly the right play. We should see some early numbers from its AI efforts, as well as more clarity over the supply situation with China. Combine that with a potential interest rate cut, and we’re looking at a perfect soup of share price growth.
To hit that $165 magic number and max out the profit for this trade, shares would only have to move 7.6% over the next two months. Considering they moved more than 50% in just the first four months of this year alone, that’s nothing for this company.