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It's a Bearish Options Trade That Wins if the AI-led Chip Stock Rally Stalls

April 16, 2024
minute read

After being in an overbought state for several months, the tech rally spearheaded by Nvidia seems to be losing momentum. In this discussion, I will delve into a bearish options strategy targeting a member of the chip sector that appears to be on the verge of a breakdown.

Examining the 6-month daily chart of the iShares Semiconductor ETF (SOXX), which tracks the chip sector, a significant bearish engulfing candle emerged on March 8th. In an upward trend, such a candle often signals an impending change in direction. This pattern is noticeable across the semiconductor space, with various chip stocks like Nvidia, AMD, and Broadcom displaying indications of a potential pullback.

Among these semiconductor stocks, Micron (MU) emerges as a noteworthy example. A closer look at MU's 6-month daily chart reveals several indicators pointing towards a forthcoming reversal in trend.

One such indicator is the Relative Strength Index (RSI), which I've utilized to gauge weakness. The RSI is a straightforward tool – when it surpasses the 70 threshold, a stock is considered overbought. However, since securities can remain in an overbought state for extended periods, it's prudent to wait for the RSI to dip below 70 before considering a bearish trade setup. Presently, this is precisely what is unfolding with MU.

Another piece of evidence stems from the price action itself. The chart depicts a series of lower highs and lower lows, affirming the downtrend.

The Trade Setup:

The trade structure employed here is termed a "bear put spread," also known as a "put debit spread."

Here's the precise trade setup:

Buy Micron $121 put, expiring on May 3rdSell Micron $120 put, expiring on May 3rdCost: $50Potential Profit: $50I've selected May 3rd as the expiration date for this trade, which is merely 17 days away. This decision is based on my experience, as bear put spreads often yield results quickly and perform optimally within a timeframe of 14-21 days.

If MU trades at or below my short strike by the expiration date, this trade has the potential to generate a 100% return on the amount at risk. With 20 contracts, this translates to risking $1000 to potentially gain $1000, with only a $1 movement in MU's favor needed.

However, it's essential to acknowledge the inherent uncertainty associated with earnings season, which often leads to knee-jerk market reactions. Any positive tech earnings released during the trade window pose a risk to this position.

Eric Ng
Eric Ng
John Liu
Editorial Board
Bryan Curtis
Adan Harris
Managing Editor
Cathy Hills
Associate Editor

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