February 1, 2023
Here is your Option Trade of the Week, as given to our Terry’s Tips Insider Members as part of the Saturday Report. With earnings season in full swing, we had lots to choose from this week. We’re back in the chip sector with a bullish play.
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KLA Corp. (KLAC) provides process-control technology to the semiconductor industry. The company reported earnings after the bell on Thursday that beat estimates on both the top and bottom lines. But the fly in the ointment came in the form of a lowered outlook for the third quarter that fell below expectations. The stock fell nearly 7% on Friday, its largest one-day, post-earnings decline in eight years.
So, why the optimism? First, analysts didn’t seem all that concerned. While there was one downgrade on the news, the stock was hit with several target price increases. The current average price target for KLAC is only about 8% above Friday’s close. That’s far from unreasonable given how analysts usually are more ebullient toward tech names. And the average analyst rating is a moderate buy, which leaves room for future upgrades.
Second, KLAC’s chart shows that Friday’s plunge, while perhaps unsettling, did not signal the end of the stock’s current strong rally. Even with the Friday drop, the stock has gained 60% in just three months. The rally has been guided by the combined support of the 20-day and 50-day moving averages. The 50-day is the key to this trade, however, as it has not allowed a daily close below it since early November. It also served as key support during a pullback in late December. Note that the short strike of our put spread is below the 50-day, so the stock will have to pierce this support to move the spread into the money.
Third, while the early returns on chip stocks (including Intel this week) suggest some rougher waters next quarter, the sector as a whole is rallying. The VanEck Semiconductor ETF (SMH) has been on a strong, month-long rally and hit a five-month high during Friday’s session.
If you agree that KLAC will continue to find support at its 50-day moving average (blue line), consider the following trade that relies on the stock staying above $390 (red line) through expiration in 6 weeks:
Buy to Open the KLAC 10 Mar 385 put (KLAC230310P385)
Sell to Open the KLAC 10 Mar 390 put (KLAC230310P390) for a credit of $1.30 (selling a vertical)
This credit is $0.05 less than the mid-point price of the spread at Friday’s $399.37 close. Unless KLAC rises quickly, you should be able to get close to that price.
The commission on this trade should be no more than $1.30 per spread. Each spread would then yield $128.70. This trade reduces your buying power by $500, making your net investment $371.30 per spread ($500 – $128.70). If KLAC closes above $390 on Mar. 10, both options will expire worthless and your return on the spread would be 35% ($128.70/$371.30).
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