Advanced Micro Devices has been trading in an increasingly tight range over the last few weeks. Chances are, it will break out of this range at some point soon.
One way to profit from a breakout is via a strategy called a long straddle. It is constructed by buying an at-the-money call and an at-the-money put.
Buying at-the-money options can be expensive. They will also suffer from time decay, meaning that they will lose a little bit of value with each day that passes if the stock doesn't make a big move.
With a long straddle, the further out in time the trade is placed, the slower the time decay. But the options are more expensive and require more capital.
For AMD stock, a long straddle could be placed by buying a 115-strike call and put for the May 16 expiration. The call was trading Wednesday around $9.75 and the put around $8.75.
Advanced Micro Devices earnings are set for late April, so the May 16 options should hold their value fairly well, even if the stock stays flat.
AMD Stock Trade Break-Even Level
When we add the two together, the total cost of the trade would be around $18.50 per contract, or $1,850.
This is the total amount of risk in the trade and the maximum loss.
Calculate the break-even prices by taking the strike price plus and minus the cost of the straddle.
That gives us break-even prices of 96.50 and 133.50. But profits can be made with a smaller move if the move comes earlier in the trade.
For example, the estimated break-even prices in mid-March are around 102 and 125.
Implied Volatility Impacts AMD Stock Trade
Changes to implied volatility will have a big impact on this trade and the interim break-even prices. So it's important to have a solid understanding of volatility before placing a trade like this.
The worst-case scenario with this AMD long straddle would be a stable stock price. That would see the call and put slowly lose value each day. For a long straddle, I usually set a stop loss at around 20% of capital at risk — that would be around $370 — and a profit target of around 40%.
I would also look to close the trade by the end of March if a big move hasn't occurred by then.
The trade starts with theta of -11. That means it will lose roughly $11 per day from time decay, with all else being equal.
AMD Stock Ratings Not So Great
According to the IBD Stock Checkup, AMD stock is ranked No. 18 in its industry group. It has a Composite Rating of 60, an EPS Rating of 97 and a Relative Strength Rating of 11.
It's important to 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
