108.3% Gain Possible… In Less Than 60 Day

Intel just announced one of its most disappointing quarters in years. It beat earnings estimates but severely missed on revenue — $18.66 billion versus an expected $19.01 billion.

Worse, the chip giant announced it expects about $16 billion for the first quarter of this year. That’s 8% lower than Wall Street was projecting.

This sounds bad… especially for finicky tech investors these days. The chip wars between Intel, AMD, and NVIDIA has been brutal, each taking shots at one another quarter after quarter. The fear is that Intel is losing this war… specifically to AMD.

Now, that’s to be determined. Next week AMD announces its own Q4 earnings. Most are expecting a better quarter than the company had last time. AMD’s last earnings announcement was so bad, it decisively ended the company’s huge rally from the first half of 2018:

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The problem then, as with Intel’s more recent announcement, is slower chip sales. Each company has new products and are fighting over market space. With so much turmoil in the market right now, investors are betting that only one can win this battle.

Since Intel announced first and lowered its Q1 guidance, Wall Street seems to be backing AMD as the likely winner. Except, it doesn’t really work that way…

You see, the two companies do compete. There’s no question there. But Intel is so much more than just a chip maker. It has the world’s largest data center group, a leader in cloud computing and networking. Its product array of chips is also much larger, with market leading positions in the PC market among others.

Now, that’s not to say Intel won’t continue to face pressure, especially from AMD. But we note all of this to point out that the market reaction to this particular earnings announcement is overblown.

The company did beat on its EPS. It has seen steady growth in its data-centric businesses. And most importantly, it has been able to do so while growing its margins and cutting costs.

The real test for investors, however, will come next week, during AMD’s announcement. If AMD doesn’t show record-breaking growth, Intel’s bearish traders will leach onto AMD instead. This recent dip gives Intel bulls a great opportunity.

Right now, the company trades at just 10.3 times its 2018 earnings. That’s remarkably low for a company that remains industry leader and is still showing record growth. This sets it up for a unique, short-term rally the minute AMD announces.

Fortunately, there’s a strategy for that…

A Strategy For Short Term Bulls

There are basically three ways for a person to make money off of a short-term rally in a stock price. First, he or she could simply buy those shares and wait for that rally to take place. The option, however, usually takes quite a bit of time and results in just a few percentage points of gain even if the trader is right.

Alternatively, a trader could buy call options. The purpose of call options is specifically designed to take advantage of short-term rallies. They give the trader the leverage of 100 shares of the underlying stock for a fraction of the cost.

If the stock does rally in a short amount of time, that trader would make many more times the profit of that movement. But this too comes with a risk. The cost of a straight call option bet can still be high, depending on the underlying stock. For instance, a March 15 $47 call on Intel costs $160 to buy right now. If shares don’t go up following the AMD announcement, the trader would be out that full amount.

There is a third way to play this kind of scenario… a bull call spread.

We’ve discussed these frequently… and for good reason. They offer a trader a similar benefit of leveraging small price movements for large gains, just like a straight call bet. But instead of putting all $160 on the line, a trader using this strategy would only have a fraction of that at risk.

The way it works is by buying a call option on a stock you believe will rise in price in the short term. Then, you sell a second call option with a higher strike price to offset some of the cost of the first. This still results in a net debit to the account. And shares do still need to rise for this kind of trade to pay off. But the risks are immediately reduced and the potential profit is immediately known.

Here’s how that looks in graph form:

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Source: The Options Industry Council

As you can see, the maximum potential profit is capped. But so is the risk. And for a trade like the one in Intel, this reduced risk is important. Let’s take a look at a specific bull call spread trade in INTC.

A Specific Trade For INTC

As noted above, a March 15 $47 call on INTC would cost a trader $160 to buy ($1.60 per share). If the trader coupled that with a short (selling a) March 15 $48 call, which costs $112 ($1.12 per share), that would result in a net debit of $48, significantly less than simply buying the call and leaving it there.

That’s also the total amount the trader would have at risk for the whole month and a half of this trade.

To find the total potential profit, take the difference in strike prices ($48 – $47 = $1) and subtract the entry cost per share ($1 – $0.48 = $0.52) then multiply by the number of shares ($0.52 x 100 shares = $52).

The $52 max profit would be a return of 108.3% on the amount at risk. To lock it in, shares would have to rise above $48 by March 15. Considering before today’s earnings announcement, Intel’s stock was trading at about $49.75, it wouldn’t take much for it to go back up. A weak AMD report would do it.

— The Option Specialist

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About the Author: The Option Specialist