Trading Strategies for Intel (NASDAQ:INTC) Post-Downgrade

Intel options strategies UBS downgraded Intel INTC to neutral from buy yesterday, lowering its 12-month price target to $19.50 from $28. UBS officials based this move on recent meetings with PC supply chain companies in Asia. They believe PC demand is weak in the near-term, which could negatively impact demand for processors. Intel’s customers are expecting to see a price reduction of 15% or more for mainstream processors.

The UBS team does not expect this environment to impact Intel alone; Hewlett-Packard HPQ, Varian Semiconductor VSEA, Western Digital WDC, and other names were downgraded at the firm. Analysts also slashed the overall PC unit growth forecast to 13.1% from 18.4% for 2010 and adjusted the 2011 growth outlook to 9.1% from 9.4%.

Intel is down almost 20% since late July and has shed 27% since its 52-week peak in early April. What’s more, the stock recently breached the 18 level, which had acted as technical support throughout late 2009 and in early July this year. Will the selling continue, or do Intel shares look like a good bargain?

We’ve outlined a relatively short-term call below for Intel bulls considering potential option strategies. For the bears who think UBS’ rationale makes sense, we’ve detailed the mechanics of a broken-wing put butterfly spread. These examples should not be viewed as trading recommendations and are for educational purposes only. All prices are as of Wednesday’s close. Intel settled at $17.90, down 22 cents on the day.

Bearish Option Strategy: Long Put Butterfly

Investors who agree with UBS’ downgrade could consider the put butterfly spread strategy. Paying an overall debit of $0.85 per butterfly spread, the October 16/17/19 put butterfly could be purchased by buying one October 16 put, selling two October 17 puts, and buying one October 19 put.

If INTC is trading right at the short strike – $17 – when these options expire on October 15, profit maxes out at $1.15, which is the widest span between strikes (19 minus 17) minus the premium paid. The maximum loss, however, is 100% of the $0.85 premium paid. Losses hit their maximum threshold only when INTC is trading at or above $19 at expiration.

This spread is what’s called a “broken-wing” butterfly, as the spread between strikes is not the same below and above the short strike. There is therefore only one breakeven price, of $18.15 (the higher-strike long put minus the debit paid). If INTC is anywhere below this level at expiration, the butterfly will be profitable.

Below the 16 strike, gains are limited to 15 cents ($15 per lot), which is the maximum profit of $1.15– achieved at the 17 strike- minus the difference between the 17 and 16 strikes. One unfortunate consequence of the broken-wing nature of this trade is the margin requirement is greater than that of a straight butterfly. The charts below are created in a virtual trading account.

Bullish Option Strategy: Long Call

Investors with a contrarian view who expect a bounce in Intel might consider buying the near-the-money October 18 call, currently priced for 66 cents per contract. The most an investor can lose with this long-call strategy is the 66-cent premium, should Intel still be trading below the 18 strike when the options expire on October 15.

Between 18 and the breakeven point of $18.66, the investor would take back at least some of the premium paid. Above breakeven, gains are theoretically unlimited. Delta for this call is currently 51.9 (but will change along with time until expiration, volatility, and other factors). But at the present, the call’s value should rise (or fall) almost 52 cents for every $1 that INTC shares advance (or decline).

Profit/Loss of Intel (INTC) long call