Dropping AMD Stock After Earnings - A Look at How Options Collars Could Have Alleviated the Struggle
In the tech world, Advanced Micro Devices (AMD) has been a standout performer, gaining 66% in the past three months. However, its rapid appreciation has left some investors, like Rob Isbitts, feeling cautious. In an attempt to protect unrealized gains while still keeping upside potential, Isbitts employed a collar strategy.
A collar is a options-based investment strategy that combines owning the stock, buying a protective put, and selling a call against those shares. The put limits losses, while the short call helps fund the put purchase, or even makes the collar net credit.
When implementing a collar on AMD, it's essential to consider the stock's volatility and liquid options market. For instance, buying a protective put with a lower strike price means cheaper protection but a larger downside risk if breached. Conversely, a higher put strike offers more protection but at a higher cost.
In the case of AMD, given its high volatility and current implied volatility (IV), it might be beneficial to choose strikes that reflect your risk tolerance and the current IV levels. Elevated IV makes puts more expensive, but it can also allow for a near-costless or net-credit collar if you pick strikes carefully.
One practical collar tactic for AMD is the cost-minimizing collar. This strategy involves selling a call near a short-term out-of-the-money (OTM) strike high enough for acceptable upside, and buying a put somewhat OTM further down. The aim is to achieve roughly zero net debit/credit if you want protection without paying much premium.
It's important to note that collars do not eliminate gap risk intraday or overnight if the stock gaps through your put strike. Therefore, it's crucial to ensure the strike and timing match your risk tolerance, especially around earnings or product announcements.
Isbitts had been using a collar strategy on AMD since he bought the stock, but this example assumes he did not use options at the moment of purchase. The collar strategy offers a 2:1 upside to downside ratio for a 3-month period, aiming to retain a big profit while reaching for more upside.
Despite the current high level of AMD, with a 2024 high around $185 not far, the daily and weekly charts do not appear urgently toppy. The all-time high of AMD was around $211, and the PPO indicator on the weekly chart is high, but not yet threatening to roll over.
While collars can be a useful tool for managing risk in volatile stocks like AMD, they do come with costs. Protective puts cost money, and selling the call may not fully fund an at-the-money put—expect tradeoffs between protection level and capped upside. Short calls can also be assigned before expiration, which may trigger realized gains/losses and tax consequences.
In conclusion, the collar strategy can be an effective way to protect gains and limit downside risk in a volatile stock like AMD, while still maintaining upside potential. However, it's essential to understand the risks, costs, and practical notes associated with this strategy before diving in.
- Given the high volatility of Advanced Micro Devices (AMD), investors employing a collar strategy might find it beneficial to choose options strikes that reflect their risk tolerance and current implied volatility (IV) levels, as elevated IV could allow for a near-costless or net-credit collar when selecting strikes carefully.
- While the collar strategy can help protect gains and limit downside risk in a volatile stock like AMD, investors should be aware of the costs associated with protective puts and the potential for short calls to be assigned before expiration, which may trigger realized gains/losses and tax consequences.
