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Advanced Micro Devices (AMD) has come down over 12% from its high on midday June 13 as it is at $113.17 on Friday, July 7. However now AMD stock is trading at an average P/E multiple. That makes it attractive to traders shorting its out-of-the-money put and call options which now have very high premiums.
We discussed a short put option strategy three weeks ago in our June 18 article, “AMD Stock May Have Much Further To Go Based On Analysts' Estimates.” For example, the $113 put options expiring on July 7 expired worthless and the $115 strike price puts closed in the money by $1.83 (i.e., $115.00-$113.17).
However, at the time of the article on June 18, the premiums were $1.82 for the $113 puts (100% profit) and $2.49 for the $115 strike price. In the latter case, a short put trader would still have made a $0.66 per put profit (i.e., $2.49 received less $1.83 in-the-money amount).
Most investors would have closed out these trades before expiration and looked for a new trade. It now turns out that AMD could be a bargain here.
AMD Stock Trades at Its Averages
For example, at $113.17 on July 7, 2023, AMD stock is now trading for just 34x earnings according to Barchart's survey of analysts' estimates for 2024 (i.e., $3.32). Moreover, CNBC reports that the stock is on a forward price/earnings (P/E) multiple of 36x.
But these two metrics are well below its historical average of 38.59x, according to Morningstar's 5-year historical average multiple.
In other words, if AMD rises to its historical mean multiple within the next year, the price will be $128.12 (i.e., $3.32 x 38.6x). That represents a minimum potential gain of 13%.
We can use that to set a target price for options trading strategies.
Shorting AMD Puts and Calls for Near-Term Income
It turns out that shorting out-of-the-money (OTM) puts and calls can generate extra income in this case, especially if the stock does not move that much. Moreover, call option premiums are especially high right now.
For example, for the July 28 option expiration period, the $119.00 call option strike price, which is slightly over 5% higher than today, has a $2.47 premium price. In addition, the $120 strike price, 6% over today's price, trades for $2.12.
These can provide an immediate income of 2.18% and 1.87% respectively for the covered call investor.
That means that any investor can buy 100 shares at $113.17, laying out $11,317 for the shares. They can simultaneously enter an order to sell 1 call option at either $119 or $120 and receive $247 or $212 respectively.
Similarly, traders can short OTM puts if they don't want to take the risk of having their shares exercised should AMD stock rise over the covered call price. For example, the July 28 $108 strike price puts, which are 4.57% below today's price, trade for $1.98.
This provides an immediate short-put yield of 1.833% (i.e., $1.98/$108.00).
That means that an investor who secures $10,800 with their brokerage firm can enter an order to “Sell to Open” the $108 strike price for July 28. The account will immediately receive $198.00. That is why the trade has a 1.833% yield.
Moreover, an even more enterprising investor can make $2.42 by shorting the $109 strike price. That represents a yield of 2.22%, but the trader must be willing to take the chance that AMD stock could fall 3.68% over the next 3 weeks or so.
Of course, one can always get out of these trades by covering the short put or call. That means entering an order to “Buy to Close” at the same strike price as originally shorted. At least this way the investor can prevent the trade from getting away from them, or take short-term profits. But in any case, they always get to keep the original income from shorting the put or call.
That is why some investors may find the recent weakness in AMD stock worth taking advantage of by shorting out-of-the-money puts or calls.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
