Advanced Micro Devices (AMD): Modest Gains, High Risk

By Josh Enomoto

• Shares of Advanced Micro Devices (AMD) popped higher on a key acquisition.

• Management revealed that it will acquire Nod.AI to bolster AMD’s AI capabilities.

• Options traders are optimistic about AMD stock but are also accounting for tail risk.

Whether the year ends early or goes the full distance, 2023 almost arguably belongs to graphics processor specialist Nvidia (NASDAQ:NVDA). At time of writing, the shares are up about 220% for the year. And while it’s engaged in some sideways trading recently, it’s still outshining rival Advanced Micro Devices (NASDAQ:AMD).

Now, don’t get this confused: AMD stock remains mighty impressive in its own right. Since the January opener, shares are up more than 70%. And on Tuesday, AMD gained just under 2% following news that the underlying technology enterprise will acquire Nod.AI, an open-source artificial intelligence software startup. On paper, the buyout should expand the chipmaker’s AI software operations.

According to CNBC, the acquisition represents a component of AMD’s “AI growth strategy,” aimed at addressing rival Nvidia’s runaway success in providing processors designed for AI protocols.

Both Chipmakers are Overpriced by Traditional Valutations

From a cursory glance, investors may be tempted to pile into AMD stock. While both chipmakers are overpriced against traditional valuation metrics, AMD seems a better deal.

Right now, AMD stock trades at a trailing revenue multiple of a bit over 8X. In sharp contrast, NVDA tips the scale at around 35X. Still, that might not be the best framework to use. After all, The New York Times mentioned that Nvidia built a competitive moat around its AI-tuned processors.

It’s doubtful that Nvidia will just give up its advantage so easily, which then brings the discussion to the derivatives market.

Options Traders Point to Moderate Upside, High Risks

Whether you’re interested in trading options or not, it’s always useful to examine this relatively underserved arena. Essentially, it’s where the smart money – the professional traders and the institutional investors who influence Wall Street – places their bets. In a way, investing without considering options dynamics is a bit like driving with a broken fuel gauge.

For AMD stock, I looked at Fintel’s options flow screener – which exclusively targets big block trades likely made by institutions – that reveals a mitigated playground. 

For options expiring in 2024 through June 2025, bought calls (which give holders the right but not the obligation to acquire the underlying security at the listed strike price) mostly concentrate around the strike price of $115 to $130.

Coincidentally, information compiled by TipRanks reveals that AMD stock carries a strong buy consensus among Wall Street analysts. Further, their average price target comes in at $137.48, implying just over 26% upside from Tuesday's close of $109.01. Based on where the bought calls’ strike prices land, I’d say $137.48 is quite optimistic.

Interestingly, institutional investors have also written (sold) call options in the previously mentioned time frame. For these transactions, the strike prices range from $140 to $180. 

You can interpret this range as the maximum perceived target. Otherwise, if shares swing higher, the call writers are obligated to fulfill the terms of the contract (sell AMD stock at the listed strike), thereby missing out on an opportunity cost in case of a robust rally.

What’s more, if these calls are uncovered, the option writers would be vulnerable (theoretically speaking) to unlimited losses, since no upside limit to a stock’s price exists.

On the other side of the aisle, major traders have also wrote (sold) put options against AMD stock. Here, the strike prices range from $110 to as low as $55. However, put option volume (whether bought or sold by the big money) tends to concentrate around the $80 to $90 level.

Comparing volume to volume, realistically, AMD stock might gain around 10%. However, realistic losses range from over 17% to roughly 27%. That’s not a great setup if you’re intending on betting the farm on Advanced Micro.

Implied Volatility Tells the Tale

Finally, the biggest indicator that AMD stock represents a moderate-reward, high-risk endeavor centers on implied volatility (IV). Per Investopedia, the textbook definition of IV is the market’s forecast of a likely movement in a security’s price. Basically, it’s used to project future changes in the underlying asset’s price.

In more colloquial terms, IV is like situational batting averages. Depending on the circumstances – strike count, runners on base or lack thereof – a batter’s average may fluctuate. For AMD stock options, its peak IV at the far out-of-money (OTM) put direction (i.e. declining price trajectory) stands at 230%. On the flipside, peak IV for far OTM calls comes in at 67%.

The above IV data from Fintel represents multiple options of the same expiration date. To be sure, it’s not the end-all, be-all. However, it also provides an insight that, generally speaking, options traders are accounting for severe tail risk to the downside. Just as significantly, they don’t anticipate much movement at higher strike prices.

That’s exactly what you’re seeing in the options flow data: relatively few traders expect AMD stock to jump substantially higher, thus the incentive to sell call options. Stated differently, if you are bullish on Advanced Micro, you might want to keep your expectations in check.

On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. None of the above should be construed as investment or financial advice. Investing is inherently risky. Please perform your own due diligence.

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