Advanced Micro Devices dropped 3% Wednesday and is below declining 21-, 50- and 200-day moving averages.
With the stock under pressure, I'm willing to bet that it will trade sideways at best over the next few weeks.
Today, I'm looking at a bear call spread that assumes AMD will struggle to get above the 160 level, which coincides with the 200-day moving average.
A bear call spread involves selling an out-of-the-money call and buying a further out-of-the-money call.
The strategy can be profitable if the stock trades lower, sideways, and even if it trades slightly higher, as long as it stays below the short call at expiry.
AMD Trade's Margin Of Error
A Dec. 20 expiry bear call spread on AMD using the 160-165 strike prices can be sold for around $0.50 per share.
Using the 160 strike as the short call gives plenty of margin for error if AMD does bounce from here.
Traders selling the spread would receive $50 in option premium. That's also the maximum possible gain. The maximum loss would be $450.
That represents a potential return of 11.11% between now and Dec. 20.
The spread will achieve the maximum profit if Advanced Micro Devices stock closes below 160 on Dec. 20. In that case, the entire spread would expire worthless, allowing the trader to keep the $50 option premium.
The maximum loss will occur if AMD closes above 165 on Dec. 20, which would see the premium seller lose $450 on the trade.
While some option trades have the risk of unlimited losses, a bear call spread is a risk-defined strategy: You always know the worst-case scenario in advance.
Bearish Trade On AMD Stock
A stop loss could be set if Advanced Micro Devices trades above 150, or if the spread value rises from $0.50 to $1.
Because this is a bearish position, traders who think AMD could move higher from here should not enter this trade. The position starts with a delta of -5, meaning it is roughly equivalent to being short five shares of AMD stock.
According to the IBD Stock Checkup, AMD stock is ranked No. 12 in its industry group. It has a Composite Rating of 66, an EPS Rating of 96 and a Relative Strength Rating of 33.
The company has already reported Q3 earnings, so this trade should have no earnings risk.
Please remember that options are risky, and investors can lose 100% of their investment.
This article is for education purposes only and not a trade recommendation. Remember to always do your own due diligence and consult your financial advisor before making any investment decisions.
Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on X/Twitter at @OptiontradinIQ
