Chip Stock Calls Peak as SMH Extends Explosive Rally

At its late-March/early April 2017 highs around $80, the VanEck Vectors Semiconductors ETF (SMH) had roughly doubled in value from its February 2014 lows. Just as notably, the fund's three-week attempt on the $80 level represented a return of about 80% from the narrow band between $44 and $46 that exerted a magnetic pull on SMH for a period of no less than two years between the first quarters of 2014 and 2016 (as highlighted on the accompanying chart).

So it's not particularly surprising that SMH stalled out and pulled back from $80 early in the second quarter of 2017, as the significance of the percentage returns attached to this area appears to have triggered a profit-taking mood among those who are long chip stocks. Over the course of that recent stretch where SMH repeatedly tested resistance at $80, etf.com data shows the fund notching its greatest daily net outflows ($58.44 million) on March 22 -- the session after SMH's intraday peak of $79.98 abruptly gave way to a closing loss of nearly 2%.

The rejection from $80 earlier this month was remarkable in the sense that SMH went slicing through its 50-day moving average for the first time since Dec. 1, whereas the fund's pullbacks in the four months intervening had all been comfortably contained by its 30-day moving average. But equally remarkable is that SMH began to rebound before it had even fallen quite as far as its previously supportive 80-day moving average. And, as of Friday's close at $78.61, SMH is now trading back above all three of these trendlines.

Given the impressive bullish momentum in SMH right now, it's fitting that call open interest in the ETF peaked Friday at an annual high of 92,340 contracts. That figure shouldn't fluctuate too drastically following the expiration of April-dated options, either, as the most popular SMH April call -- the 77 strike, which expired in the money -- carried open interest of not quite 6,000 contracts as of Friday morning.

Instead, most popular by a margin of nearly 2-to-1 is the August 84 call, with 34,408 contracts in open interest. And while at least a third of these calls were sold to open, according to data from the major options exchanges, it stands to reason that SMH shorts -- a contingent that expanded its ranks by 6% over the last two reporting periods, despite the ETF's long-term rip higher -- may have purchased these out-of-the-money, record-high-territory calls as hedges. If that's the case, will an SMH rally above $84 be sufficient to finally press these stubborn shorts into covering? Because a 7% gain over the course of the four months left until those August 84 calls expire would be, by SMH's standards, eminently achievable.

Meanwhile, the SMH action around $80 could also be instructive in context of the fund's eventual move up to $90, should the chip tracker continue its seemingly relentless charge higher. SMH $90, it should be noted, is not only the site of a double from that historically significant $45 range, but also a 50% gain from the $60 level (which served as a "hard stop" for SMH back in May 2015 before marking the site of the fund's pre-bull gap highs in mid-July 2016). In that respect, any initial hesitation on SMH's first tests of $90 could present shorting opportunities -- albeit on a very short-term basis.