In 2024, the semiconductor sector is experiencing remarkable performance despite some recent volatility in earnings reports. The predominant investor sentiment is one of continued optimism, with many expecting the rally in semiconductor stocks to persist through the end of the year. However, this prevailing bullish outlook has prompted some seasoned traders to recommend caution. As a former Chicago Board of Trade (CBOT) pit trader, I believe it might be an opportune moment to hedge semiconductor exposure to guard against potential downturns.
One approach to managing risk in this scenario involves utilizing put options related to the VanEck Semiconductor ETF (SMH). This strategy aims to mitigate downside risk while maintaining exposure to the sector. Nvidia, a leading player in the semiconductor industry, recently reached an all-time high of $140.89 following strong results from Taiwan Semiconductor, a major supplier to Nvidia. Nvidia constitutes 21% of SMH's portfolio, thus significantly influencing the ETF's performance.
Despite these positive developments, there are some cautionary signals. ASML, a prominent Dutch microchip equipment maker, recently disclosed delays in the expected market recovery, leading to a decline in its share price. Nonetheless, Nvidia's CEO has consistently expressed confidence in the robust demand they are experiencing, forecasting continued strong performance, with further clarity expected during their earnings announcement on November 21.
While I remain committed to maintaining a presence in the artificial intelligence sector, my strategy involves hedging and strategically booking profits, particularly given that SMH has already appreciated over 40% this year after a 72% rise in 2023. It’s reminiscent of an old trading adage: "Pigs get fat, hogs get slaughtered," which serves as a reminder to avoid complacency in a bullish market.
Analyzing the technical setup, I foresee a potential retest of the 50-day moving average around $228 for SMH. My current trade involving a put spread includes purchasing an SMH, regular expiration Nov. 15 $245 Put for $7.00 and selling a Nov. 15 $225 Put for $2.50. This results in a net cost of $4.50 or $450 per one-contract spread. When this trade was executed, SMH was trading near $252. Should the strategy bear out, the potential profit is the difference between the strike prices ($20) minus the cost of the spread ($4.50), equating to $15.50 or $1,550 per spread.
Understanding your notional exposure to semiconductors and determining how much you are prepared to invest in downside protection is crucial in deciding the appropriate number of spreads to own. Always consider your individual financial situation and risk tolerance before pursuing this or any investment strategy. It's prudent to consult with a financial or investment advisor to ensure that any financial decisions are suitable for your particular circumstances. As with all investment insights expressed here, these perspectives are personal and not reflective of any institutional or corporate opinions.
