Aggressive options trading in semiconductor stocks has created a volatility spread that traders are using to remain bullish on the most rising sectors while simultaneously hedging against market-wide risk.
Trading is very simple. Sell downside protection for semiconductor stocks with high volatility and buy downside protection for semiconductor stocks. S&P500the VIX has reached a three-month low this week and is relatively cheap.
This is why this article is so uniquely appealing at the moment.
implicit volatility VanEck Semiconductor ETF (SMH) is 46, more than 2.5 times higher than the S&P 500. CBOE Volatility Index (VIX) Volatility often decreases as stock prices rise, but in the case of chips, prices move in a parabolic fashion and volatility increases with price.
VanEck Semiconductor ETF, year-to-date
As a result, traders have shifted some of their SMH call buying appetite to selling puts, with more than five times as many puts sold as calls bought on Wednesday. We remain bullish on the sector, but more specifically target high option premiums.
The second part of the trade is to use the proceeds to go long S&P 500 volatility through index puts or VIX calls.
“Win-win”
Even if your tips increase, your net credit will remain the same. If the chips fall, the stock market will likely fall as well, and the S&P puts will benefit. Plus, there’s a bonus kicker to this deal. Volatility is rising with the price of the chip, so even if the group sells, volatility could fall, giving traders an even bigger cushion for the puts they sell.
S&P 500, year-to-date
“Even if the market goes up, the S&P puts won’t lose much value, so the premium you get from selling them will far exceed the premium you lose on the index,” said Scott Bauer, CEO of Chicago-based Prosper Trading Academy. “This is highly volume skewed and a pullback in the semis would give us an opportunity to reload at a lower price, while selling the call could be a career-ending trade. It could definitely be a win-win.”
Wednesday’s intraday action provided a classic example of how both trades can be winning at once. Semiconductors and VIX both hit lows around 9:20 a.m. PT, then both rebounded and hit the bell.
