An Attractive Way to Play Intel’s Undervaluation

This week, the semiconductor industry remained in the news with NVIDIA’s extremely disappointing third-quarter earnings announcement. The company missed analyst targets for both EPS and revenue.

This weak announcement resulted in shares collapsing, down 19% today. It’s too early to tell just where the dust will settle on this major chipmaker. But it could give a signal to another.

Intel is one of the largest integrated chipmakers in the world. It has been an unpopular stock for quite a while, due to it losing market share to AMD as consumers have trended away from traditional PCs (where Intel dominates) and into mobile products. Still, the company is no slouch.

It has annual revenues of $69.4 billion, a market cap of $222 billion and pays a stable — if not too exciting — 2.5% dividend. It is also an industry leader not going anywhere. Nonetheless, the market is holding back from putting too much into INTC shares.

Right now, the company’s stock is valued at just 10 times expected 2019 earnings. That’s about half of the rest of the market and one-third AMD. It certainly has room to grow.

The concern, however, is the nature of its business itself. Much is riding on Intel’s future products. It is developing a 10-nanometer chipset that would replace the current 14nm ones everyone is using now. It is also working on a replacement for that chipset with a 7nm one in development.

That’s how fast this industry moves. It was after all Intel’s founder, Gordon Moore, for which Moore’s law is named. That’s the one that states that components in integrated circuits (chips) doubles each year. Meaning each year brings twice the computing power with it. This has mostly been the case for decades.

So, until investors get a better clue as to what Intel’s plans are for these developments, they seem to be sitting on their hands. Intel’s board of directors, however, is not.

Yesterday, hours before NVIDIA was set to announce its disastrous earnings numbers, Intel announced its board’s approval to increase its share buyback plan by $15 billion. That’s in addition to the $4.7 billion left from the last one. While Intel is not a small company, this is still a large chunk of change. This works out to about 9% of the company’s entire market cap.

Now, if investors are hoping for more news from Intel before they decide to jump back in, they may be in for a bit of disappointment. The company doesn’t announce its next earnings until late January. That’s part of the reason shares aren’t trading higher on the news of NVIDIA’s fall. But it also sets up a nice window to enter a trade for anyone bullish on Intel.

Either a Surprise or a Year-End Reallocation Could Boost Intel

Intel is not just going to go dead silent until its earnings. While the company has a history of keeping its financial performance under wraps until earnings announcements, it is anything but a quiet business.

It would be quite in the industry leader’s M.O. to announce some updates about its upcoming chipsets before January. In fact, the company is going to participate in a large conference later this month that could prove exciting to some in the industry. Intel CFO and Interim CEO Robert Swan is actually going to kick off the Credit Suisse Media & Telecom Conference with a keynote speech. That’d be the place for something exciting.

Regardless of any surprise news about its chips, the company’s undervaluation will remain attractive in this period of portfolio readjustment and year-end reflection for some investors. It quite possibly could see a little kick much sooner than its next earnings announcement.

Fortunately, there’s a perfect strategy to play just such a potential movement.

A Perfect Trade For Short Term Bulls

A bull call spread is one where a trader buys a call at or near the current stock’s price and sells a call with a higher strike price. This results in a net debit. That’s the trader’s total capital at risk for the duration of the trade.

The total profit potential of such a trade is the difference between strike prices in the calls minus the premium paid to enter them.

For a stock like Intel, with such low volatility this often gives a bullish trader a nice return on their risk.

The point of such a trade is to benefit from short-term increases in share price without the risk of losing the full cost of buying a call option.

This graph shows you just how this strategy works:


Source: The Options Industry Council

As you can see, your downside is limited at just the amount it takes to enter the trade. The upside, too, is limited, but can often be easily achieved.

Let’s look at a specific bull call spread for Intel.

A Specific Bull Call Spread Trade On INTC

If one were to buy a December 21 $49 call for $1.49 per share and sell a December 21 $50 call for $1.04 per share, they’d pay $0.45 per share. Since each call represents 100 shares, that works out to a net debit to their account of $45 to enter this trade.

That’s the total amount at risk. If shares of Intel remain below $49 until expiration next month, that $45 is the most they’d have to lose.

The potential profit on this specific trade is measured by taking the difference in strike prices ($50 – $49 = $1) and subtracting the debit to enter the trade. So, for this bull call spread, that works out to $55 ($1 – $0.45 = $0.55; $0.55 per share x 100 shares per contract = $55).

This means that if one were to enter this trade today, their potential profit would equal 125% of the amount they have at risk.

With more than a month left before expiration, the possibility of Intel reaching $50 per share and paying out this full reward is high. There are no guarantees, of course. But if Intel picks up any new investors looking for discounts in that time, it is definitely a potential winner with this trade.

— The Option Specialist

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About the Author: The Option Specialist