In the world of markets, few things are absolutely predictable, but one certainty is that for most stocks, the majority of price volatility occurs outside of market hours. This is primarily because earnings announcements are released outside of market hours, leading to significant price swings. Consequently, the implied volatility of options tends to rise as these uncertain events approach, particularly around earnings announcements.
Our previous earnings-based trade involved a long strangle on Nvidia, which was quite successful until the implied volatility crush that occurred at earnings. However, the call options we suggested appreciated significantly, allowing for a two-for-one position. This meant you could have sold one and effectively gotten a free look at Nvidia's earnings. Alternatively, you could have taken profits before the event, achieving a substantial gain. The highest return I recorded for this trade was 156%, although the upside was limited by the put side of the trade.
This time, with $TSM (Taiwan Semiconductor Manufacturing Company), I'm adopting a more aggressive approach. Analysts increasingly hint that TSM could outperform even the high end of its optimistic guidance. As one of the world's indispensable companies, TSM is often in a position to set prices.
We’re doing a similar trade except not a strangle. We’re doing what your momma told you not to do, we’re getting a little naughty. I’m so confident in this company outperforming in this bull market environment, and leaving analyst expectations in the dust, that I’m going to suggest a straight OTM call option. That’s right. Spicy and simple.
TSM's fortunes are closely tied to Nvidia, and I won't spend much time explaining the company's global significance. If you're on this site, you likely already know that. Instead, I'll highlight several tailwinds for TSM:
The aggressive Fed cutting cycle could alleviate pressure on valuations.
The increasing odds of a Kamala Harris victory suggest reduced tensions with China compared to a Trump win.
A Harris victory would maintain the Biden administration's policy of defending Taiwan in the event of a Chinese attack.
Economic weakness in China has redirected international capital flows to other Asian markets, with Taiwan's stock market likely benefiting from this trend.
I'm a big fan of TSM and believe that much of the geopolitical risk surrounding the company would diminish with a Harris victory. While the true military situation is obscured by posturing on both sides, when the CSIS war games it out, China consistently loses when attempting to invade Taiwan. The logistical challenges of supplying an invasion force make it unlikely to succeed, even if it reaches the island. U.S. military dominance remains intact, and Taiwan is a savvy international actor that has effectively protected its interests and its national treasure—the foundries upon which the digital age depends.
We are very bullish on TSM and the market in general over the next few months. The Fed has cleared the way for the next leg of the bull market, and we believe Taiwan Semiconductor will be at the forefront of gains. TSM has beaten earnings estimates over the past four quarters, and I expect it will do so again in its next earnings report in October, based on the trend of revisions.
I anticipate that TSM will ride the seasonal trends into the end of the year nicely, given the strength of market fundamentals and the quality of the company. I'm confident in suggesting a pretty aggressive long position. I want to provide enough time value to capture the full impact of positive seasonals, so I'll be looking at options with a longer expiration.
A significant catalyst will be the earnings report in October. For those who are risk-averse, this may be an opportunity to sell if the stock experiences the usual run-up in implied volatility that occurs before earnings reports. The typical implied volatility crush that follows could be an opportunity to lower the cost basis on your contracts.
While TSM does face some risks, such as economic weakness in China potentially weighing on earnings, I doubt it will counteract the strength of AI demand enough to impact earnings significantly. TSM has consistently exceeded expectations and is well-diversified by geography and product type.
Overall, I expect the semiconductor sector and TSM to be primary beneficiaries of the bull market moving forward. The recent market rotation has been healthy, but I believe semiconductors will start performing well again as the bull market aligns with positive end-of-year seasonals.
Here is the trade:
Buy the January 17th, 2025, $200 call options, currently trading around $8.20. Given the scale of today's rally in technology, you may want to wait for a tactical pullback to purchase the contracts. I believe you can likely acquire them in the $7 range tomorrow.
The earnings report in October will be a major catalyst. It may be beneficial to set stops around this event, just in case. However, my analysis indicates that the October earnings will be favorable for the stock.
