Aggressive options trading in the semiconductor sector is creating volatility spreads, allowing traders to maintain a bullish stance on this top-performing industry while hedging against broader market risks.
The strategy's logic is straightforward: Sell downside protection options on individual semiconductor stocks, where volatility premiums are elevated, while simultaneously buying downside protection on the S&P 500 index, where volatility remains relatively cheap. This week, the VIX fear index touched a three-month low.
This approach is particularly attractive at the current juncture for several reasons: The VanEck Semiconductor ETF (SMH) exhibits an implied volatility of 46, which is more than 2.5 times the volatility level of the S&P 500. In contrast, the CBOE Volatility Index VIX is currently trading near 17. Typically, volatility declines as the market grinds higher. However, the semiconductor sector is experiencing a parabolic rise, with its volatility increasing alongside the rally in stock prices.
Market data reflects this trend: Consequently, traders are shifting their preference from buying SMH call options to selling put options. On Wednesday, the volume of put options sold was more than five times the volume of call options purchased. This still represents a bullish bet on semiconductors, but specifically aims to capture the high premium income from options.
The second step of the trade involves using the premium income generated from selling these options to go long on broader market volatility, either through S&P 500 put options or VIX call options.
The 'win-win' rationale is as follows: If semiconductor stocks continue to advance, the trade generates steady net premium income. If semiconductor stocks decline, the broader market is likely to weaken in tandem, causing the S&P 500 put options to become profitable. An additional advantage: Rising semiconductor prices drive volatility higher. Even if the sector subsequently pulls back, its volatility may also decline, providing an extra safety cushion for the put options sold by traders.
Scott Bauer, CEO of Prosper Trading Academy in Chicago, commented: "The premium income harvested from selling semiconductor put options would significantly outweigh any losses generated on the index side. Even if the broader market rises gradually, the S&P 500 put options won't depreciate substantially. There's a notable volatility skew present currently; if the semiconductor sector corrects, you can re-enter at more favorable prices. In contrast, selling call options can lead to devastating losses if the trend reverses. This strategy can truly be considered a win-win scenario."
Wednesday's intraday price action served as a classic example of the strategy's two-way profitability: Around 9:20 AM Central Time, both the semiconductor sector and the VIX fear index hit their intraday lows, then proceeded to rally together until the market close.
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