To The Moon

Artificial Intelligence (AI) server provider SMCI will release its Q1 FY2025 earnings on November 5. The market expects the company’s Q1 revenue to be $6.453 billion, a year-over-year increase of 204.43%, and earnings per share (EPS) of $0.68, a year-over-year growth of 146.69%.

Despite the optimistic outlook for SMCI’s Q1 performance, its stock price has fallen nearly 80% over the past eight months. SMCI was added to the S&P 500 index before the market opened on March 18, during a period when the AI server manufacturer’s stock reached an all-time high with a cumulative gain of an astonishing 295%. However, the stock has been on a downward trend since then, with the decline becoming more pronounced from mid-July.

Various factors, including audit-related issues, have weighed on SMCI’s stock performance. On October 30, SMCI announced that its auditing firm Ernst & Young had resigned, citing an inability to rely on financial data provided by management and the audit committee. Earlier in August, well-known short-seller Hindenburg Research accused the company of “accounting manipulation” and other suspicious activities. Shortly afterward, Nasdaq issued a compliance notice to SMCI for failing to submit its annual report (10-K) on time.

According to TipRanks, bearish investors believe risks remain, as uncertainties around internal controls and the delayed 10-K filing have intensified their caution. However, bullish investors argue that SMCI is well-positioned to benefit from the growing investment in AI infrastructure, supported by its strong product lineup.

For trading after SMCI’s earnings release, options traders might consider a bearish call spread strategy.

What is a Bearish Call Spread Strategy?

A bearish call spread is an options strategy used when a trader expects the underlying asset’s price to decline over time. The trader aims to short the asset while limiting risk within a specific range.

Specifically, a bearish call spread is achieved by purchasing a call option at a particular strike price while selling the same number of call options with a lower strike price, both with the same expiration date.

Example of Shorting SMCI

Taking SMCI as an example, suppose SMCI’s current price is $26, and an investor anticipates a drop to around $20 by December 20. The investor can use a bearish call spread strategy to short SMCI.

• Step 1: Sell a call option expiring on December 20 with a strike price of $20, collecting a premium of $910.

• Step 2: Buy a call option with the same expiration date and a strike price of $27, costing $525 in premium. This establishes the bearish call spread.

• Sell Call Option: Strike price of $20, premium income of $910

• Buy Call Option: Strike price of $27, premium expense of $525

• Net Income: $910 - $525 = $385

Profit and Loss Analysis

1. Maximum Profit:

   1. If SMCI’s stock price is below $20 at expiration, both options will expire worthless, and the net income of $385 is retained.

   2. Maximum Profit = $385.

2. Maximum Loss:

   1. If SMCI’s stock price is above $27 at expiration, the sold call at $20 will be exercised, requiring the investor to sell at $20, while the bought call at $27 allows buying at $27, resulting in a loss.

   2. Maximum Loss Calculation: $27 - $20 - $3.85 = $7 - $3.85 = $3.15.

   3. Maximum Loss = $3.15 × 100 = $315.

3. Breakeven Point:

   1. The breakeven point is when SMCI’s stock price reaches exactly $23.85, as this level offsets the spread loss with the net income of $3.85.

The main advantage of a bearish call spread is reduced risk in shorting, as buying the higher strike call helps offset the risk of selling the lower strike call. This approach carries much lower risk than directly shorting the stock, which theoretically has unlimited risk if the stock rises.