Aggressive options trading in semiconductor stocks is currently creating a volatility spread that traders are leveraging to maintain a bullish stance in this sector while hedging against broader market risks. The strategy involves selling downside protection in semiconductor stocks, where implied volatility is high, and buying downside protection in the S&P 500, where it is relatively low.
This week, the Cboe Volatility Index (VIX) reached its lowest level in three months, trading around 17, while the VanEck Semiconductor ETF (SMH) has an implied volatility of 46, which is over 2.5 times higher than that of the S&P 500. Typically, volatility decreases as stock prices rise, but in the semiconductor sector, prices are increasing sharply, causing volatility to rise concurrently.
On Wednesday, traders sold more than five times as many puts as calls in SMH, indicating a shift in strategy that still reflects a bullish outlook on the sector but focuses on capitalizing on the high premiums of options. The income generated from selling puts is then used to invest in long volatility positions in the S&P 500 through index puts or VIX calls.
This approach offers a dual benefit: if semiconductor stocks rise, traders retain the net credit from the puts sold; if they fall, the S&P puts are likely to gain value as the broader market declines. Scott Bauer, CEO of Prosper Trading Academy, emphasized that the premium from selling puts will exceed potential losses on the index, making this strategy advantageous.
He noted that if there is a pullback in semiconductor stocks, it provides an opportunity to re-enter at lower prices, contrasting with the risks associated with selling calls. The trading activity on Wednesday illustrated this strategy effectively, as both semiconductor stocks and the VIX experienced lows before rallying later in the day