AMD Stock Today: Why A Butterfly Spread In Advanced Micro Can Reap $390 In Profits

By Gavin McMaster, Investors.com

Advanced Micro Devices (AMD) has experienced a nice rally in recent months, moving from 60 in early January to as high as 102 last month. Alongside AMD stock, semiconductor firms have been performing well generally.

According to MarketSmith, the fabless semiconductor industry group ranks No. 1 among 197 industries tracked by IBD in six-month price-weighted performance.

Lately, AMD stock is underperforming against Nvidia (NVDA). So I'm willing to look at an option trade that will profit if AMD stock comes back down toward the 50-day moving average in the next week.

The trade is a directional butterfly, centered at 90 with the view that AMD stock might retrace to that level.

The butterfly trade holds both limited risk and a limited profit. But on a typical butterfly trade, the profit potential rises above the potential loss. And in this case with Advanced Micro, it's a lot higher. Plus, placing the trade out-of-the-money means it can be done for a low cost with a high profit potential.

AMD Stock Today: Setting Up The Trade

Butterfly spreads involve three different option strike prices, all within the same expiration date, and can be created using either calls or puts.

As we are placing the butterfly in AMD stock below the market, we will use puts in this case to reduce the risk of early assignment.

Here's the trade I'm looking at, based on prices late Tuesday:

• Buy 1 April 21-expiring 85-strike put @ 0.35
• Sell 2 April 21, 90-strike puts @ 1.20
• Buy 1 April 21, 95-strike put @ 3.15

Therefore, the trade in AMD stock costs a total $110, the maximum loss potential. You can calculate the maximum gain of $390 by taking the difference in strike prices less the premium paid, or $500 less $110. If AMD doesn't get down to 90, I lose a little bit, but have the potential for a large payoff if it does hit 90 in about 9 days time.

For a trade like this, it either works or it doesn't. So, traders should mentally get prepared to lose the whole $110 if it doesn't work out.

AMD stock ranks highly in IBD ratings, including a 98 Composite Rating, according to IBD Stock Checkup.

Please remember that options are risky, and investors can lose 100% of their investment.

Gavin McMaster has a Masters in Applied Finance and Investment. He specializes in income trading using options, is very conservative in his style and believes patience in waiting for the best setups is the key to successful trading. Follow him on Twitter at @OptiontradinIQ

From Investors.com