ON Semiconductor is a profitable multinational company that makes sensors for industrial solutions and the automotive industry. I am interested because of the comparatively high implied volatility percentages in the stock’s out of the money options. I think it is important to read all the available public disclosures for the companies I might invest in. Here is what I learned.

Fixed Contracts

A significant portion of the company’s revenue comes from long-term supply agreements that are not cancelable and are recognized as revenue when the products are shipped to the customers. This gives the company reliable revenue sources and good visibility into what future revenue will be. If ON results come in below the company’s guidance, it should indicate a problem with management’s ability to fulfill orders and be a rather negative indicator of operating competence.

Having started and still running a retail business this business structure appears to be so easy to run. You already have your sales before you make anything. There is no “purchase the inventory and hope to sell it”. No convincing financiers that their loan will be safe. It might not be the most profitable spot, but by eliminating most of the unknowns with sales, they sure can sleep soundly at night.

Future of Automobiles

ON sales by customer segment.

This is a direct quote from their 10Q. “We believe the evolution of the automotive industry, with advancements in autonomous driving, ADAS, vehicle electrification, and the increase in electronics content for vehicle platforms, is reshaping the boundaries of transportation. Through sensing integration, we believe our intelligent power solutions achieve superior efficiencies compared to our peers. This integration allows lower temperature operation and reduced cooling requirements while saving costs and minimizing weight. In addition, our power solutions deliver power with less die per module, achieving higher range for a given battery capacity.”

I am not sure if EVs are going to take over. I also don’t know if they will figure out how to make autonomous driving. I am sure that cars are not going to have less sensors, smaller batteries, and get heavier. ON appears to be positioned so they will benefit from further advancements.

Stock Repurchase Plan

The company buys back around 1 million shares per quarter for the last year. Last quarter the average purchase price was $94.48. They appear to be doing it regardless of what the price is. I assume that there is a price that is too high for them to continue to repurchase stock. Whatever that price is, we have not gotten there yet.

Other

• In 2023 they laid off 1360 employees.

• 2 employees entered into agreements to sell shares in ON in the next year. A director and the CFO. 

Trade Idea

This is not advice. If it was, I would advise you to not do what I suggest below and instead get a qualified money manager to assist you with your investments. I included this in my blog with the hope that you might have insight to offer me or you might find my thought process interesting. Please comment below!

I sold puts that are over 6% out of the money and that expire in 7 days. My model says there is above an 80% chance they will expire out of the money and Interactive broker’s (IB) trade analysis has it at 92%.

My model uses historic ON stock price data to calculate the number of times ON has moved down by the required amount and then divides that by the total sample size. I included all days ON has been a public company in the data. I do not know how IB calculates their percentage. 

The key to this trade being successful is what happens if the unlikely happens and the stock price falls by more than 6% in the next 7 days. Here is the plan.

1. The first contingency is to allow enough portfolio liquidity to maintain the position. A big drop followed by margin calls would lock me into losses and potentially put me out of business. The largest loss ON has ever experienced in 7 days is 47.3%. Therefore, I limited the amount of contracts sold so that if the underlying dropped by 48% I will still have some excess liquidity to maintain the position.
2. I will roll the position down and out one week if the underlying gets within $.50 of my strike price. This means I will buy back the puts I sold for an estimated $1.10 per contract. I will then sell the same amount of contracts that expire one week later at a lower strike price for a similar price. I think it will cost $1.10 because that is how much the at-the-money put costs right now. This will lower the strike price the underlying needs to stay above for my puts to expire worthless and give them an additional week to do it.
3. ON has bought back over 1 million shares per quarter this year. There is also an 8% short interest in this stock. In the event of a precipitous decline, it is my hope that both the company and the shorts will step in and buy stock.