How Allegro MicroSystems (ALGM) Can Outpace AMD in Boosting Returns

Business Insider

2 days ago

With the advent of artificial intelligence, it's no surprise that semiconductor giants like Advanced Micro Devices (AMD) have surged in value in recent years. However, the company isn't immune to pressure, as its latest financial disclosure demonstrated, with statistic hot-shots like Allegro MicroSystems (ALGM) waiting in the wings.
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Thanks to investors increasingly ramping up their expectations, hiccups against key benchmark figures can result in tremendous volatility, as we've just witnessed in AMD stock.
For the second quarter, Advanced Micro reported record revenue of $7.7 billion, representing a 32% jump against the year-ago period. Fundamentally, much of the growth could be attributed to strong demand for server and PC processors. Not surprisingly, the latest sales tally beat Wall Street analysts' consensus view of $7.41 billion.
Unfortunately, the company couldn't sustain the same magnitude of momentum on the bottom line. Adjusted earnings per share landed in line with the consensus estimate. However, this figure represented a huge decline of 30.4% on a year-over-year basis.
In terms of outlook, management guided Q3 revenue to reach approximately $8.7 billion, reflecting 28% year-over-year growth. Notably, this forecast swung past the Street's estimate of $8.3 billion. Still, it wasn't enough to prevent an initial panic in AMD stock following the disclosure. That said, the equity entered this past weekend on a high note.
With the bulls once again demonstrating their resilience, AMD stock may look interesting to options traders. However, there's another overlooked chipmaker that astute speculators may want to consider.
AMD's Shining Moment Has Passed
To be 100% clear, I'm not trashing AMD stock. If you genuinely believe that the security offers viable upside, I won't protest. However, the point I'd like to make is that based on a statistical framework, AMD lacks a confidence-inspiring signal.
In the options arena, the financial publication industry focuses heavily on convoluted concepts such as implied volatility, unusual activity, and the Greeks. While these are certainly intriguing datapoints, that's all they are. It's like looking at the speedometer — useful, perhaps, to avoid getting a traffic ticket, but having this knowledge alone won't make you drive like Max Verstappen.
Here's the ultimate truth when it comes to options: it doesn't matter how cheap your option is if the probabilistic risk of failure is sky-high. No amount of Greek fluency can save a trade destined for the dumps.
As such, I'm a big believer in discrete-event analysis. Rather than view share prices in their native form as continuous scalar signals, I prefer to convert and categorize price action into discrete, defined states.
For example, in the past 10 weeks, I'm no longer interested in how AMD stock transitioned from one price point to another. Instead, I look at how the market voted to buy AMD seven times and sell three times. During this period, the security enjoyed an upward trajectory. For brevity, we can label this sequence as 7-3-U. For a deeper delve into my proprietary quantitative analysis and how 'sequences' are derived, readers can refer to previous articles.
The goal of categorizing these 10-week sequences is to use past analogs to determine how the market responds to them. As a baseline, the chance that a long position in AMD stock will rise on any given week is 55.07%. This is effectively our null hypothesis, the probabilistic expectation assuming no mispricing. However, our alternative hypothesis is that, because of the 7-3-U sequence, the odds have changed.
Sadly, the odds change to the projected detriment of bullish traders, with the probability of upside shrinking to 40.43%. This translates to a downside probability of 59.57%, which, in my opinion, isn't enough to justify an outright bearish position. From a trader's perspective, AMD stock is stuck in no-man's land.
Allegro MicroSystems: The Arguably Better Alternative
For those seeking speculative growth, I would much rather consider Allegro MicroSystems. A semiconductor specialist, Allegro designs, develops, manufactures, and markets sensor and power integrated circuits (ICs) that are used in a variety of applications, especially in the automotive and industrial sectors. While ALGM stock doesn't command the footprint of an AMD, it's a name respected by several market experts.
Since the start of the year, ALGM has gained nearly 46%, which is an impressive performance. However, in the past month, the security has been down roughly 17%, thereby presenting a discounted opportunity for aggressive traders. It's not just about the red ink; rather, the statistical profile is very compelling.
In the last 10 weeks, the market voted to buy ALGM stock six times and sell four times. During this period, the security swung upward. Again, for brevity, we can label this sequence as 6-4-U.
Here, the baseline probability — or the null hypothesis — is 50.8%, barely a positive bias. However, with the 6-4-U sequence flashing, our alternative hypothesis stands at 63.89%. Therefore, an incentive exists to consider a debit-based options strategy.
From past analogs, the median expected performance assuming the positive pathway is 4.88% in the following week when the 6-4-U sequence flashes. If the bulls manage to maintain control of the market for the next three weeks, traders may anticipate an additional performance boost of 1.41%. With ALGM stock closing at $30.77 on Friday, the upside target could be $32.73, possibly $33 if the winds move favorably.
Thanks to the structure of the options market right now, a compelling idea may be buying the $30 call expiring September 19 outright. Presently, the ask on this contract is $2.50 or $250 when applying the options multiplier. Based on intrinsic value at expiration, the breakeven price for this trade is $32.50.
Another trade to consider for extreme speculators is the 35/40 bull call spread expiring on November 21. This transaction involves buying the $35 call and simultaneously selling the $40 call, for a net debit paid of $120 (the maximum possible loss). Should ALGM stock rise through the short strike price of $40 at expiration, the maximum profit is $380, a payout of about 317%.
Keep in mind that looking that far ahead is difficult for any forecasting model to get right. However, I will say that the p-value (from a one-tailed binomial test) of the 6-4-U sequence is 0.1353. This means that there's a 13.53% chance that the implications of the signal could materialize randomly as opposed to intentionally.
I can't call this a statistically significant signal, but it remains an empirically intriguing sequence within the stock market's open and entropic system.
Is ALGM a Good Stock to Buy?
Turning to Wall Street, ALGM stock carries a Strong Buy consensus rating based on nine Buys, two Holds, and zero Sell ratings over the past three months. ALGM's average stock price target is $38.09, implying almost 20% upside potential.
Allegro Offers a Superior Options Trading Opportunity Than AMD
While Advanced Micro Devices has been a fan favorite, there's growing evidence that traders are getting stretched with AMD stock, putting the security in ambiguous air. In contrast, ALGM stock offers a much clearer probabilistic signal, making it an intriguing alternative.