As Anthropic races to go public, cracks are appearing in the AI trade, and the impact isn’t limited to end companies.
We recently wrote about Coreweave. Coreweave fell 15.5% on October 14 as the yield on the 2032 Treasury reached 15% and the default swap spread nearly doubled in October. IREN has fallen more than 20% this year. Last Thursday, the virus also hit chipmakers, which is not surprising since so much of CRWV and IREN’s spending goes to chipmakers. AMD Shares fell 8.1% as Meta funding plans and a supply warning from Lam Research exacerbated data center concerns about the pace of AI spending.
So why be so bullish?
That’s because when you screen for factors that produce clear outperformance over time, the list narrows quickly. My screen: Price is above the 200 day moving average. Revenues are growing at least as fast as the S&P 500 (over 5% per year). EPS grows at least as fast (7%+). Rating upgrade. PEG less than 3; ROE and ROIC greater than 12%. Of all the companies reporting in the next two weeks, AMD is effectively the only one on the list. Sure, you can (and probably should) position your portfolio with slightly less technology exposure than the broader index provides, but you can’t completely ignore the market’s largest and most transformative sectors.
Especially since the growth in this case simply doesn’t meet my standards. It passes them by. Consensus for the third quarter is calling for EPS of $1.94 and revenue of $13.06 billion. This compares to $1.20 and $9.25 billion in the same period last year. This is approximately 62% and 41% year-over-year growth, respectively. The recent drawdown is due to a decline in the sector, and while AMD hasn’t reported anything, it shows that if some names in the space take a hit, even the big players are likely to feel it. On October 6th, Lisa Su said that AMD will significantly increase supply in 2027 as AI orders continue to exceed production capacity.
AMD since the beginning of the year
So how can fast-growing companies balance the elements that we know work against a backdrop of rifts in the AI industry? Options.
trade
Owning the stock outright means absorbing approximately 9% to 11% of the implied movement associated with (intraday) earnings. Earnings releases are about a week away, but the smallest change over a similar period over the past four quarters was more than 9%, and the largest change after the company announced first-quarter results was 38%. Of course, that kind of volatility means options aren’t cheap, and their high premiums are also a reason not to just buy calls.
Call spread risk reversal serves both roles. Mitigating the risk if the crack widens, the short option offsets the increased volatility you would otherwise pay. The chart below shows that sacrificing about $1,700 of upside to gain $5,000 of outperformance during a tough downturn is a way to stay in the trade with considerably less risk given the recent volatility of this trade. Specifically, it’s $5,000 cheaper. Of course, you’ll get some cash when you sell it, but it’s less than just buying the stock. Also, selling both outs and calls reduces long call purchases by 66%.
Disclosure: Tidal owns/holds all securities mentioned in the article.
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