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Last week Taiwan Semiconductor Manufacturing Company Ltd (TSM), a large semiconductor fabrication company, released a surprise increase in April revenue. As a result, call options in TSM stock are having unusual activity today, underlining its underlying value. TSM directly benefits from the increased focus on cloud server and AI chips.
For example, TSMC is a preferred fabricator of high-performance GPUs and specialty AI chips designed by Nvidia (NVDA), which is set to release its quarterly earnings today.
Surprise Revenue Increase
The recent report was a surprise to the market. On April 18 the company's Q1 earnings report indicated that net revenue, although up +12.9% Y/Y was down -3.8% vs. the prior quarter. So the news on May 10 that TSMC's April revenue was up +20.9% M/M from March 2024 hit the market as a pleasant surprise.
Moreover, the company said this was up +59.3% over the prior year's monthly revenue. The market concluded that Q2 revenue could show a huge increase.
As a result, TSM stock has been spiking. In morning trading on Wednesday, May 22, TSM stock is at $156.08 per share. This is up +13.6% from $137.34 at the end of last month and +22.2% higher than its recent low of $127.70 on April 19, before its Q1 earnings release.
Barchart Unusual Options Activity Report
As a result, today the Barchart Unusual Stock Options Activity Report shows that a large volume of call options has traded at the $157.50 strike price for the June 7 expiry period, 16 days from now.
For example, the Report shows that over 1,000 call options contracts traded at this level. That represents over 7 times the outstanding number of call option contracts that were open before today's activity.
Moreover, the midpoint premium was $4.35 for these calls. That implies that long buyers of the calls may expect to see TSM stock rise to over $161.85 (i.e., $157.50 +$4.35), or +5.78% higher than $156 per share within the next two weeks.
That is a very bullish call option investment by long buyers. Undoubtedly, this may be a derivative play on Nvidia earnings coming out today. For example, if Nvidia's revenue are a blowout, that implies that TSM's revenue will continue to shoot higher with upward surprises.
Relative Valuation
Moreover, TSM earnings forecasts are relatively cheap, if compared to Nvidia. For example, a survey of 5 analysts by Barchart shows a forecast of $6.13 per ADR (American Depository Receipt) for this year and $7.63 for next year. Seeking Alpha shows an average of $6.31 this year and $7.87 next year. The average of these two is $6.22 this year and $7.75 for next year.
As a result, on a run rate basis, we can say that sometime in the next 12 months (NTM) TSMC will be on a run rate of $6.99 per ADR. That puts the stock, at $156 on a NTM multiple of just 22.3x earnings.
This is well below the multiple of one of its main clients, Nvidia. For example, NVDA stock trades on a forward multiple of between 29.7x and 37.6x, or 33.65x on an NTM basis. That implies that TSM stock is trading at just ⅔rds the valuation of Nvidia.
So, as traders see it, if the same revenue increases are occurring at both companies, the valuations of both companies should eventually converge. Or at least the TSM stock valuation is due for some sort of increase to close the gap.
Should Investors Buy the Calls or Sell Them?
The problem is - will this really occur over the next 2 weeks? That is the period that this call option has to work for long buyers. It actually might make sense to sell covered calls. That is also a bullish move.
For example, buying the calls at today's price and simultaneously selling call options at the $157.50 strike price or even higher strike prices allows the investor to make capital gains. They also get to collect the income from selling the call options. This is also attractive to investors who repeat this trade every 2 weeks.
In this case, the potential income yield is 2.79% (i.e., $4.35/$156.00) on the spot price. Over the next 90 days, if that can be replayed, the expected return (ER) is 5x to 6x 2.79%, or 13.95% - 16.74%. The income for covered call sellers also provides some downside protection in case TSM stock falls.
The bottom line here is that TSM stock could be undervalued. One way to play this is to either buy long calls, a risky play or to sell covered calls, a less risky play.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
