Aggressive options trading in semiconductor stocks creates a volatility range that traders use to remain bullish on the sector that is gaining the most while hedging risks in the broader market.
The trade is pretty simple: sell downside protection on semiconductor stocks, where volatility is expensive, and buy downside protection on S&P 500where it is relatively cheap, with the VIX hitting its lowest level in three months this week.
That’s why it’s particularly compelling at this time.
Implied volatility in the VanEck Semiconductor ETF (SMH) is 46, more than 2.5 times the S&P 500, where the Cboe Volatility Index (VIX) The price is around 17. Often volatility decreases as stocks rise, but in the case of chips, where prices move parabolically, volatility increases in tandem with prices.
VanEck Semiconductor ETF, YTD
As a result, traders are shifting some of their call buying appetite in the SMH to selling puts: on Wednesday, more than five times more puts were sold than calls were bought. It is still an optimistic assessment of the sector, but it is particularly aimed at the high premiums of the options.
The second part of trading is to use this income to take long positions in the volatility of the S&P 500 via index puts or VIX calls.
“Win-win situation”
If the chips go up, you keep the net balance. If the chips go down, the stock market most likely will too, and the S&P puts will pay off. Additionally, there is a bonus kick to trading: Since the volatility of the chips has increased with their price, it is possible that even if the group sells, the volatility will decrease, giving traders even more cushion for the puts they sell.
S&P 500, YTD
“The premium you get from selling the puts will far exceed what you would lose on the index because even if the market goes up, those S&P puts won’t lose much in value,” said Scott Bauer, CEO of Chicago-based Prosper Trading Academy. “It’s a massive vol skew, and if there’s a dip in the semis, you have the opportunity to reload at a lower price, whereas selling calls could be a career-ending trade. It can absolutely be a win-win.”
Wednesday’s intraday action was a prime example of how both trades can win at the same time. Semiconductors and VIX both hit their lows around 9:20 a.m. CT, then both recovered toward the bell
