That Didn’t Work
When U.S. markets fell on Monday, in the wake of the Nikkei’s record point drop, we (my subscribers and I) placed a few bullish trades in the Portfolio Armor trading Substack. One of them was on Super Micro Computer, Inc. SMCI, as I wrote about in a post here at the time (There Goes Tokyo).
Let’s look at why we placed the trade, why it didn’t work, and what we’re going to do differently next time.
The Rationale Behind Our Bullish Trade On Super Micro
In Monday’s post, I mentioned three reasons why Super Micro Computer looked like a good bet:
- The strong recent earnings report by chipmaker Advanced Micro Devices, Inc. AMD suggested that the recent AI boom wasn’t a bubble.
- Super Micro Computer looked oversold, with an RSI (Relative Strength Index) in the 20s.
- Super Micro Computer looked inexpensive on a PEG basis (Price/Earnings ratio divided by its growth rate).
With that in mind, while shares of SMCI tumbled on Monday, we placed an options trade betting that the stock would climb over $595 by the end of the week.
For A Moment It Looked Like It Might Work
SMCI reported mixed earnings after the close on Tuesday: it beat on revenue, and offered bullish guidance, but it missed on earnings, due to margin compression.
The market reaction after hours on Tuesday was bipolar: first the stock spiked above $720, only to fall below $550 a few minutes later.
As I type this on Wednesday afternoon, the stock is trading below $500.
Lessons We Can Draw From This
The first thing to note is that if you trade options, you’re going to be wrong a lot no matter what you do. It’s harder to be right with options than stocks because options expire, so you need to be right by specific date. If we had simply bought shares of SMCI on Monday, we’d be down now, but 6 months or a year from now, we’d have a good chance of being up on the trade. With the option trade we placed on Monday, we needed to be right by Friday’s close, and that looks extremely unlikely at this point.
The tradeoff is that you can get bigger gains when you are right with options than stocks, as was the case with our trades on Meta Platforms, Inc. META and Carvana, Co. CVNA last week.
That said, I think there are few lessons we can draw from our SMCI trade this week. In our current risk-off market:
- Cheap on a PEG basis isn’t cheap enough. Going forward, we’ll look at valuation more broadly. On a scale of 0-to-10, with 10 being the best, SMCI had an overall Valuation Rating of 4 according to Chartmill earlier this week. Next time we bet on a beaten-down stock, we’re going to look for a 6 or better.
- Low RSI isn’t low enough. Going forward we’ll look for technical consolidation.
- Weekly trades aren’t long enough. Going forward, we’ll give our trades more time to play out.
- Wait until after earnings. In this market, we’re going to see stocks that beat on top and bottom lines drop after earnings too. Better to bet on beaten-down stocks when this quarter’s earnings are in the rearview mirror.
Defeat Laps And Victory Laps
After I wrote this, I checked my email and there was a message from a subscriber, telling me to “take a victory lap” on PetIQ, Inc. PETQ. I hadn’t checked the news on it until then.
If You Want To Lower Your Risk
If you want to take less risk in this market, you can use up days to hedge. As a reminder, you can download our iPhone hedging app here, or by aiming your iPhone camera at the QR code below.
Another approach that may be worth considering is the Hedged Portfolio Method, which I wrote about here last year.
By the end of the week, we’ll have the final, 6-month performance of our first hedged portfolios to run through the Monday’s historic Nikkei crash. I’ll share that performance here when I have it.
We also have a couple of short trades teed up for the next time our target stocks bounce. If you’d like a heads up when we place them, feel free to subscribe to our trading Substack/occasional email list below.
If you’d like to stay in touch
You can scan for optimal hedges for individual securities, find our current top ten names, and create hedged portfolios on our website. You can also follow Portfolio Armor on X here, or become a free subscriber to our trading Substack using the link below (we’re using that for our occasional emails now).
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