3.5+ decades of data analyzed
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As concerns regarding the overvaluation of stocks are still prevalent in the market, at times rightly so, the concerns of market participants regarding a sharp price readjustment event (price crash) are also still elevated. History teaches that crashes occur and can be closer than our' animal spirits' may want to accept.
Thus, it is always beneficial to stay prepared. This report analyses the following questions, utilizing data: How much can the stock price of ADVANCED MICRO DEVICES, INC. (NASDAQ:AMD) crash or fall in a market crash/decline? How much risk of losses can it expose investors? Price fluctuations under average levels of volatility?
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Long-term (monthly) analysis:
The findings & assessment conducted regarding the decline of the overall U.S. stock market in our report (see: How Much Does the US Stock Market Fall/Decline on Average in a Market Crash?) indicated that the average decline of the U.S. equity market stands at about 25.5%.
The 98% confidence interval range stated a range of -8.5% to -42%, i.e., as per the data analysis of previous crashes, we can state with confidence that the overall price decline of the U.S. equity market in the next such event should be within the aforementioned range, with only a 2% probability of a decline greater than the above-stated range.
This report builds on that work, taking into account the systemic risk of AMD's price in relation to the overall market to ascertain a data-based analysis of how this stock's value can decline in the next adverse market event, etc. A Value at Risk analysis and a low-risk exposure strategy is also discussed.
The first input required in this analysis is the beta of (NASDAQ: AMD) in relation to the market proxy (the measure of systemic risk).
Beta calculation results:
It must be noted that even though the long-term beta stands at about 2.3%, we must use recent data for a more accurate analysis. The beta of the stock in relation to the S&P 500, as per recent data, stands at 1.9984.
How much is ADVANCED MICRO DEVICES' (AMD) stock price expected to fall/decline in a market crash?
Data from the last 100 years of market crashes has been examined in our report (How Much Does the US Stock Market Fall/Decline on Average in a Market Crash?) This data is utilized to gain insights regarding the current query.
As per over 100 years of crash/decline data, and the long-term and current covariance data, we can claim that AMD's stock, on average, is expected to fall by about -51.1% in a crash, a very concerning figure. Additionally, as per the 98% confidence interval calculated utilizing previous adverse market events, we can confidently claim that AMD's stock price may decline in the range of -17% to -84%.
As it is a high beta stock, these figures relay pessimistic values. The expected decline figures are concerning, to say the least, and warrant further examination, conducted below. See also: Why do all financial assets correlatively fall in a market crash
The worst monthly performance observed:
As per the assessment of the last 3.5+ decades of monthly returns (1985 onwards), the worst monthly performance of AMD has been a decline of -47.73% in a month. This figure supports the results of the calculations explained above. Nonetheless, for further precision, a value at risk VaR analysis has been conducted below:
VaR analysis (95% confidence level)
The results reveal a monthly VaR of 28% and a yearly VaR of 96.6%.
What does this mean, simplistically?
This means that as per the calculations of value at risk, i.e., how much an investor can lose, the results indicate that monthly losses, 95% of the time, should be equal to or lower than $278.9 per $1,000 invested in this stock. The losses per year, 95% of the time, should be equal to or lower than $966.04 per $1,000 invested.
An alternative way of looking at these values is that the aforementioned values are the minimum amount of losses that can occur 5% of the time, i.e., 95% of the time we can confidently claim that loss should be as stated above, however, 5% of the time the above-calculated values may be the minimum losses.
All in all, we can see that it is a high-risk stock & investors should seriously evaluate their strategy before jumping in. As per the VaR analysis, an investor can lose almost all their investment in a year by holding AMD. It has crashed by about 50% in under a month in the past, and as per the current analysis, it can fall more than 50% in value in a short amount of time.
How can investors safely gain exposure to (NASDAQ:AMD), however?
Due to the potential of considerable upward moves, investors may be interested in AMD. The stock, in the past, has increased by as much as 78.1% in a month (01/01/2001). Such appreciation potential can seduce the animal spirits in investors, and the prospect of extraordinary returns can trigger reckless risk-taking. After all, one can also lose about 96% of their investment through exposure to the subject.
A reasonable alternative would be to acquire call options to limit the risk. Options' premium, nonetheless, due to the high volatility, are likely to be considerable. Usually, the premium on 1-year calls is likely to be in the range of 20-35% of the current price. However, investors can use a simple rule of thumb for limited risk exposure:
The long-term growth rate of this stock currently stands at about 5.2% p.a. (geometric mean); thus, in periods without expectation of specific exceptional risk occurrences, those wanting to gain exposure to the subject should keep up-to-date on option prices.
If calls are priced at or below 5.2% of the current market price, then, as per the average long-term growth rate, the investor shouldn't lose money by acquiring them, as the yearly growth rate stands at 5.2% (i.e., if 1 year call premium is about $8 per share, and the market price of shares is $150, the call(s) should be acquired). Those with a higher risk tolerance can consider buying calls when the premium is higher.
For example, if the call premium is 15.2% of the underlying stock price at the time of acquisition, those with a higher risk tolerance can acquire the option, and their risk exposure, as per historical returns, would be 10% (15.2%- 10%). Nonetheless, options, as explained earlier, are likely to demand a higher premium, and thus, a higher level of risk acceptance may be necessary for gaining exposure to the subject.
Still, by acquiring options, one can gain exposure to AMD's stock with a limited, quantified amount of risk exposure that does seem more viable than buying and holding.