Eric Fry is teasing us about the coming “A.I. Wars,” and the necessity of building more and more advanced AI-ready chips in the United States and reducing our reliance on Taiwan and South Korea, and the heart of his pitch is that some companies will see huge profit opportunities as semiconductor capital spending grows to fight these “A.I. Wars” in the coming year, much like roads-and-bridges infrastructure companies have during past big spending periods.

The ad is for Fry’s The Speculator newsletter ($1,999/yr, no refunds), which seems to recommend mostly speculation through long-dated call options (more on that in a minute), and this is how he sets the stage for the “A.I. Wars” he sees coming as the US tries to ramp up chip production and reduce our reliance on Taiwan:

“They have to solve this A.I. chip problem before it’s too late.

“Elon Musk has even said that these essential chips are ‘considerably harder to get than drugs’…

“It’s why the CHIPS Act will direct hundreds of billions of government money toward this sector.

“It’s truly a state of national security.

“So we’re going to have plenty of opportunities in the coming months as A.I. chip expansion grows and these government-mandated funds are sent out.

“And I’m expecting some truly amazing investment opportunities to pop up in the coming weeks…

“Similar to what happened with Congress’s Infrastructure Act and Inflation Reduction Act…

“I’ve actually already pinpointed one trade to take action on immediately. That way you can get in before February 1st deadline….”

So what’s he recommending? We’ll get to that “one trade” in a moment, but it takes a while to get to the few clues he’s willing to drop for us…

The first half of the ad is mostly made up of claim of big gains on some infrastructure-related stocks in 2021, as the infrastructure spending act was being passed and companies in construction and other areas who might benefit soared… but the charts indicate that what Eric Fry is recommending here are longer-term options trades, not necessarily equity investments. He says we could “more than 3x our money” if we timed an investment well in Oshkosh, for example, or Martin Marietta or Caterpillar… but in all those cases the stock actually only went up by 10-20% over a period of 2-3 months, so the more extreme 200%+ gains he’s talking about would have had to come from buying call options.

I’ll go into that in much more detail at the end of this piece, since I don’t want to bore those of you who already perfectly understand options, but what Eric Fry is mostly talking about here is buying LEAP options, which are longer-term options — LEAP call options in this case, so they’re bets on the stock price going up over a period of at least 6-8 months, sometimes 1-2 years. (LEAP options aren’t really different than regular options, they’re just “options that expire more than a year from now” — most options trading takes place with shorter timeframes of 1-4 months.)

But what stocks specifically is he betting on in this way? Well, the reason he uses the construction companies as his past ‘win’ examples is that they generally got a boost from the talk about infrastructure spending in 2020 and 2021, and the strong construction activity as builders were going mad putting up new houses and apartment buildings in places like Boise, Idaho, as everyone from San Francisco and Los Angeles fled for less-crowded places during the work from home/shutdown times.

And he thinks something similar is going to happen with the CHIPs Act and other government stimulus that’s pointed at building more semiconductor capacity in the United States. Here’s how he gets into that in the ad:

“The law’s main goal is for the U.S. to compete once again with countries like South Korea and Taiwan in semiconductors.

“… the CHIPS Act gives the U.S. an opportunity to catch up. It will mobilize hundreds of billions of dollars… and shoot it like water through a fire hose at the U.S. semiconductor industry.

“At the federal level, the CHIPS Act incentives consist of $200 billion for scientific R&D and commercialization…

“There’s $39 billion for chip manufacturing…

“$13 billion for chip R&D and workforce development…

“And $24 billion for a 25% investment tax credit.”

If you’re talking about building big new semiconductor foundries, those might end up just being “table stakes” — building a new fab will probably cost you at least a billion dollars and take a few years, and the really big ones, at least in the US, are likely to be in the $10-20 billion range, perhaps a bit more, and take five years or more to build. Taiwan Semiconductor (TSM), for example, is likely to put $40 billion of capital spending into the complex of foundries its building in Arizona, and that’s before they figure out how to hire and train the thousands of workers needed to operate the plant.

But still, yes, that’s a lot of federal money going into the semiconductor space. And, as with pretty much every past stimulus program and infrastructure spending bill, the money will mostly be going out the door years after the bill was passed — and in this case, the CHIPS Act was passed in August of 2022, so we’re closing in on 18 months now. (I moved to this part of the world in 2010, just as an aside, and I remember that the 2008 infrastructure bill spending really began to hit our bridges and highways with new projects in 2012-2013 — that’s not atypical, the stimulus and the economic impact are real, but the planning needs and lead time for big projects, combined with government requirements and bureaucratic inertia, mean the impact tends to come pretty slowly.)

More from Fry:

“More than a year has passed since the CHIPS Act became law, but it has not dispersed any funds yet. That’s because the law required companies to apply for the funds.

“That process has been taking place for several months. But the time is almost here for the government to break open its piggy bank and start handing out billions of dollars to hand-picked companies in the semiconductor industry.

“And hundreds of millions in new funding are going to be set into motion starting February 1st….

“As we speak the U.S. government is vetting which companies are going to receive funding and which ones won’t…

“This new funding will focus on the construction, expansion, or modernization of commercial facilities in the United States for semiconductor materials and manufacturing equipment.”

The government started working with big potential recipients of CHIPS Act funding about a year ago, but last fall they did open up the funding process for smaller projects (the “big vs. small” cutoff is $300 million), but according to the Commerce Department (which is handling about $50 billion worth of these incentives and awards), it looks like only a couple projects are in the advanced stages of due diligence at this point.

The “February 1, 2024” deadline is not necessarily a critical deadline for all CHIPS Act funding, it’s just the deadline for concept plans to be submitted for potential applications for one segment of the CHIPS Act, the one specifically focused on smaller supply chain projects for the semiconductor industry. The “most promising” concept plans will lead to an invitation to submit a full application, dates for that are unknown at this point.

So yes, there may be a press release about submission from some smaller companies… and there may even be news in the months to come as some of those projects move past the “concept plan” phase, but it will probably be pretty slow.

And in the end, Fry teases that his special report will reveal, “The Top Five 10X Trades for the A.I. Wars of 2024″… but he only actually hints at one of those trades, so that’s probably all we can reveal for you. Here’s the language leading up to that…

“President Biden held up a semiconductor designed by this company at the White House Chip Summit and said, ‘This is infrastructure.’

“Now I want to be clear this isn’t a political endorsement from me by any means…

“But the President is right.

“Semiconductor devices are used in everything from electronic control systems in vehicles to warfighters to smart phones.

“And this company is currently in the process of building a $1.8 billion Semiconductor Manufacturing Facility in Partnership with the State of Indiana and Purdue University….”

He drops a few other hints about this company…

“… the Chips Act is already spurring new projects that will be vital to domestic manufacturing, supply chains, and national security…

“And with these tight government connections I believe they could be set to receive incoming funding starting February 1st which could shoot up share prices.

“Not to mention it’s major investors include BlackRock… The biggest asset manager in the world… Along with Vanguard… The world’s second biggest asset manager.

“So I like the setup for this trade a lot.”

And on the order form:

“During the previous federal fundings that hit our backtest, Eric’s strategy could’ve returned peak gains of 4,900%! That turns $1,000 into $50,000!

“Don’t miss this chance to position yourself with Eric’s #1 A.I. Winner. It’s a company Eric has confirmed already has EXTREME ties to the U.S. Government.

“That means this stock could receive funding shortly after the February 1st deadline.

“But with Eric’s groundbreaking strategy, you could see 1,000% gains or more.”

OK, so… what does all that mean?

Almost every single company you can think of, other than the tiniest microcaps or the most speculative stuff that’s not in any indices, will have Blackrock and Vanguard among its largest owners. More than half of the money in the stock market is effectively “passive,” invested primarily in index funds or their equivalent or trying to match the performance of the market or a particular chunk of the market (small caps, or oil companies, or retailers… almost everything has an index or an ETF). And Blackrock and Vanguard are the largest managers of institutional money and index funds, so they, along with a few other usual suspects (State Street, Fidelity, Northern Trust, etc.) typically make up most of the top of the “cap table” for any stock, you’ll find that at least a few of those asset managers are almost always among the top ten shareholders of any mainstream company.

But yes, we do know which chip Joe Biden was holding up in that photo… and we do know who’s building that “$1.8 billion semiconductor manufacturing facility” in Indiana. So we can at least name the “first trade” company for you… this is a tease about Skywater Technology (SKYT), which pops up fairly often when people are talking up “reshoring” of semiconductor fabs, because Skywater, through a series of quirks of timing and fate, is one of the few surviving pure-play US semiconductor manufacturers.

There are roughly 20 foundry facilities operating in the US, many of them legacy facilities from a few decades ago that are still hanging on because they’re strategic subsidiaries of large companies, like Honeywell or Intel, or, like Skywater, do a lot of military work (many more facilities from the 1970s and 80s shut down long ago because of lower-cost overseas options), but most of them are quite small.

In the past, the only real strategic concern about manufacturing semiconductors in the US came from the US military — the military insists on domestic chips, and they also have some other specific requirements for durability (radiation hardening, etc.) for a lot of their equipment, so SkyWater and a few other small fabs have survived over the years largely because the military is willing to pay a premium for relatively low-end chips if they’re built in the US.

And, yes, SkyWater has also gotten a fair amount of government funding in the past, largely from the Department of Defense, though they are still a very small company — they operate one real foundry, in Minnesota, and a smaller facility that’s mostly an R&D location in Florida… and they have a plan to build a $1.8 billion facility in Indiana in partnership with Purdue University and the State. That new facility is dependent on CHIPS Act funding to move forward, so it has not broken ground yet, but it makes sense that they would be an early applicant for funding and probably a pretty appealing one — though we should probably hesitate to count our chickens, given that we’re still just looking at eggs in the nest.

So… what does all that mean when it comes to trading? Well, Eric Fry is talking up some kind of options trade on SkyWater, and it’s a very small company so some sudden interest from a bunch of subscribers should show up in the options trading — this is not a particularly liquid stock anyway, with a $400 million market cap, but the options are particularly illiquid, with most contracts not ever really trading. And because they’re small, there are no LEAP options available — you could speculate on something happening almost immediately with the February 16 expiration, and there is a large open interest in the February $10 calls… but beyond that, if you want more time for this to play out, the call options that have high open interest are the April 19 $10 calls (around 75 cents), the July 18 $10 calls (around $1.25), and the more speculative July 19 $17.50 calls (around 25 cents). “Open interest” is just the number of existing contracts for that strike price and that expiration date that exist right now — every time a new call option is created (“buy to open”), the open interest goes up, when a contract is “sold to close” it goes down, all else being equal. None of the available contracts have meaningful trading volume today, and most of them typically do not trade in a given day, so the bid-ask spread can be wide and it can require some patience to build a position in an options contract for a small and relatively un-followed company like SkyWater.

My guess? It would be a little wild for a newsletter to speculate on a surge in just the next couple weeks, particularly since SKYT probably won’t even have its next earnings report until after that February option expiration date has passed, so most likely Fry is recommending the April or July $10 call options. SKYT should report its next two quarters in late February and early May, so going with July gives you two more quarterly updates, and those tend to be the largest drivers for stock prices… but, of course, it’s always possible that there will be a big, splashy announcement about CHIPS Act funding for SkyWater Indiana, or some other government contract or funding plan for their other facilities, and it’s those kinds of announcements could also move the stock. It’s a tiny company, with a market cap of about $400 million and revenue of less than $300 million, and they haven’t yet reported a profit, so the share price might be quite volatile.

Analysts currently expect them to make the turn to profitability sometime in the second half of this year, so things are looking up… and they have plans to build a semiconductor packaging operation at their Florida site, which might attract government funding, too.

But while funding may look likely, and this is a rare US-based small cap semiconductor manufacturing company, which means they’re unique and can gather a lot of attention, which can attract shareholders… we should mention that this was also the case the first time we looked at SKYT, when Dave Lashmet over at Stansberry was teasing the stock in the Summer of 2021 — back then it was a billion-dollar company, having gone public earlier in that year (after a private equity firm bought the Minnesota fab from Cypress Semiconductor, shined it up and got some government grants and expanded capacity, and took it public at an optimistic valuation). The CHIPS Act hadn’t been passed yet at that point, but the theme of re-shoring chipmaking was certainly in the wind, and they were already reliant on Department of Defense funding.

What does that mean for SKYT shares? Well, over the next six months there should be more news about CHIPS Act funding projects moving forward, so there’s some potential that SKYT could be connected to one or more of those projects. I don’t know what the odds are, particularly within a short time period like that, but SkyWater is clearly only going to move forward with their Indiana project if they get CHIPS Act funding, either this year or in the next few years (most of the funding is expected to be doled out over about five years). The controlling private equity shareholders of SKYT have gradually reduced their stake, so the number of shares held by the various entities and offshoots of Oxbow Partners, mostly under the management of SKYT Director Loren Unterseher, has been reduced by about a third over the past year, probably putting a little selling pressure on the shares — and that could continue, I don’t know what their plans are for the longer term.

As of last quarter, SKYT is still burning cash, and they’re running a little low on cash, too, particularly with $50 million or so of debt that has to be refinanced this year (total debt is close to $150 million — $45 million on their credit line, $50 million in current debt (due this year), and another $38 million of long-term debt). That’s probably not a problem, particularly if their customers keep paying and they begin to get some CHIPS Act funding… but it’s certainly possible that a lean year, or failure to get CHIPS Act or other government funding, would mean they might have to sell shares or seek outside capital, which is generally bad for shareholders.

For me, this is a logical investment because of the clear government focus on building up and expanding capacity in the US, and SKYT is small enough to be a big beneficiary of even some minor CHIPS Act funding… but it’s not an obviously successful or cash-flowing entity on its own at this point, and the industry remains very competitive at the low end, particularly if you don’t insist on US manufacturing, so I think I’d probably pass on SKYT shares. I can see how a bet on the options might be interesting, given the chance that they could get good CHIPS Act funding news this year, particularly since we have some evidence of how this company can move on news — the shares went from $6 to $18 when the CHIPS Act was passed in the Summer of 2022 — but I won’t be betting on this particular horse race.

Sound interesting to you? Have other stocks that appeal for CHIPS Act speculation? Let us know with a comment below.

And for those who want to stock around, we can also point out the freebies that Fry “revealed” in his presentation, and go into a bit more detail on what Fry’s kind of (usually) longer-term options speculation might look like, for those who are unfamiliar with options trading.

First, the freebies — from the end of Fry’s presentation:

“… the A.I. stock I’m recommending to completely stay away from in 2024 is Manpower, ticker symbol MAN…

“Even before A.I. burst onto the scene, Manpower was a slow- to no-growth enterprise. Although solidly profitable, its annual revenues are no higher today than they were 12 years ago, and its annual net income has tumbled more than 40% since 2018.

“And A.I. introduces some significant new risks to Manpower’s business model…

“For starters, some companies may start bypassing staffing firms like Manpower by taking a do-it-yourself approach to hiring the workers they need. A.I.-powered tools such as resume-screening websites like ZipRecruiter enable companies to source and evaluate employment prospects directly, without the need for human recruiters.”

OK, I doubt even anyone on Manpower’s executive team could claim they’re an “A.I. Stock” with a straight face. ManPower is a cheap stock, but their revenue has also been pretty much flat, gradually declining, for about 15 years. The “disruption” in the temporary staffing industry took place starting a long time ago, I don’t think we can really blame Manpower’s general weakness as an investment on the “A.I. Wars.”

And his free pick:

“… the A.I. stock I believe could be a big winner in 2024 is Intel, ticker symbol INTC.

“The company is spending tens of billions of dollars to build next-generation semiconductor fabs in the U.S. and Europe.

“And I believe A.I. is a big part of the reason for this daring strategic maneuver.

“Now you can buy this stock if you’d like, I think it has the potential to do quite well.

“But if you are interested in multiplying your potential returns even more with LEAPS plays, I highly suggest you join The Speculator and see how it’s possible to chase 1,000% gains.”

Intel reported a rough quarter last week, causing the stock to drop about 20% from its highs of earlier this year, but it’s certainly true that they’re a likely recipient of CHIPS Act funding, too, and are working on substantial new foundry investments in the U.S. as they try to rebuild their growth engine and become a meaningful competitor for Taiwan Semiconductor (TSM). Investors have been convinced of the turnaround and then disappointed in Intel’s stagnation a few times over the past decade or so, and the current expectation of analysts is that they’ll show some earnings growth this year, though with revenues ~6% lower than had been hoped a few weeks ago, and earnings ~25% lower, and that the growth which had been expected in 2024 will partially push out to 2025. The estimates now are for $1.36 in adjusted earnings per share in 2024 and $2.32 in 2025, so if you start looking out a year then INTC at $42 is trading at about 18X forward earnings.

There is very active options trading on Intel, so Fry’s attention probably wouldn’t have an impact, but there are real LEAP options trading on this one — the January 17 2025 options with a strike price of $40 are trading right now at about $7.80, for example, and the same strike price with a January 16, 2026 expiration is at about $10.75, so you can put up roughly a quarter of the price of buying the stock to get all the upside exposure for two years. You just give up the first ~20% of gains, effectively, and if you’re wrong on the downside and Intel falls by, say, 10% over the next two years, you get a 100% loss. And you could even make it more extreme — there are also December 2026 options available on Intel now, so you could get leverage going out almost three years. For a little extra money, of course.

So let me just dig into that idea of long-term options trading, and talk about how that kind of leverage works for a minute.

Options speculation, you’ll be unsurprised to learn, can work awfully well when the market is going up, like it certainly was in the Fall of 2021, which is the time frame that Eric Fry uses for his past “infrastructure” wins on some construction-related companies. And the market has been going up lately, too. Just don’t go imagining that somehow getting a 200-300% return from a stock that goes up 10% in two months is safe or easy — the major risk is that a relatively minor shift in the share price, say, falling 10% instead of rising 10%, would mean a 100% loss of your investment.

Nobody likes to lose, but seeing the value of an investment drop by 10% (as almost any stock will, most years, though the shareholder gets to decide whether they hold on or sell or even buy more), and actually losing 100% of your investment in a timed trade, which is what happens with the majority of call option speculations, are entirely different experiences. Leverage always works both ways.

So sometimes it’s best to think of these types of trades in terms of how they’d work inside your portfolio… indulge me for a moment as we run through an example.

If you don’t know the basic mechanics of options trading, each call option contract gives you the right, but not the obligation, to buy a stock at a set price — the strike price — anytime before the expiration date. In the US, standard options can be exercised at any time before expiration, but most of the time investors don’t end up exercising their option and actually buying the underlying stock, they just “sell to close” the contract and take their profit (if there is a profit) that way. The most appealing part of an option is that you get upside exposure, and you know exactly what your downside risk is — if you buy a call option, you can’t ever lose more than 100% of what you spend to buy the option, you’re under no further obligation. The odds of a 100% loss are high, but, unlike other kinds of leverage (buying on margin, short-selling), you can’t lose more than you put in.

Put options are just the opposite of call options, they give you the right to sell that stock at a set price, so you should see that contract rise in value if the share price drops… and as the expiration date nears you’ll end up with a profit if the share price falls below your put strike price. You don’t have to own the underlying stock, just the right to sell it, so these are even more rarely exercised, since “exercising” would mean buying the stock at the then-lower price, then exercising your put option to sell it at a higher price — it’s easier to just to sell the contract to close it out at the fair price, assuming there’s a rational bidder on the other side (there usually is).

The language is a bit old-fashioned now, but when buying into an options contract you’re buying the right to “call” shares from someone else at a price, or “put” them to someone else at a price. In general, selling options is more consistently profitable than buying options, and many people sell options to generate income, like covered-call selling when you sell off some of the near-term upside potential of stocks you already own in order to generate extra cash, but it’s not as exciting for gamblers because there’s no real potential for windfall gains when you sell options… it’s more like betting on the favorite to show at your local racetrack — you win most of the time, but you don’t win very much on any one bet.

So let’s look at an example, using one of the past winners Fry teased:

Caterpillar (CAT) right now is trading right around $305. If you happen to believe that we’ll see a nice positive move in the share price over the next year, you could buy the CAT January 17, 2025 call options at a strike price of $310, only 1-2% above the current price, and that option would cost about $34 per share ($3,400 per contract, standard call options only trade in 100-share increments). If CAT goes up by 20% in the next year, then you were right and you’ll reap the rewards — your options will roughly double in value (maybe much more, if the stock price moves up quickly while there’s still a lot of time left before expiration). If CAT moves from $305 to ~$370 over the next year, then the CAT $310 call options should be worth at least $60 at expiration, roughly a 100% gain from the $34 you’d probably have to pay today to buy that option. It’s just math — if you own the right to buy CAT at $310, and CAT trades up to $370, then your “right” is worth $60. If it trades up to $60 much faster, in the next month or two, and there is still a long time to go before expiration, it will likely trade up well above $60, because there’s still “time value” in the contract, traders will bid on whatever it’s worth to them to get the potential additional gain in the stock over the next ten months — maybe a small premium, maybe a large one, it mostly depends on how speculators feel about CAT’s prospects at that time.

If the shares soar dramatically higher, your returns multiply — CAT has had a few years in the past decade when the stock went up close to 50% in a year, if that happens then the shares might be around $450 a year from now, your options are worth something like $140, and you’ve got about a 300% return. That’s not the most likely outcome, but it’s possible.

But the flip side is dramatic, too. If this year turns out to be a weak one, and the S&P 500 is roughly flat, and maybe CAT falls 5% on the year, your call option would gradually become worthless as the months tick by, and you’d end up with a 100% loss. If CAT is trading at $290 in December or January, with the stock generally drifting down and sentiment low, then the option to buy shares before January 17, 2025 at $310 would be worth probably just a few dollars in December… and a few cents by the time you get to a week or two from expiration. If CAT falls more meaningfully, with a bad earnings report next quarter that drops the price to $240, and it takes a couple years for the stock price to get back to $300, then your options will almost certainly be a 100% loss.

If the S&P 500 has an average year, and goes up exactly 10%, and CAT follows that path perfectly and also rises 10%, then you’d probably just about break even. The stock would end at $335 a year from now, and the option to buy shares at $310 would be worth $25 at expiration, or perhaps a few dollars more if you sell to a shorter-term speculator in the weeks leading up to expiration. You probably end up with a slight loss, selling those $34 options for $25-30 as we close in on the expiration date in a year, though options are usually quite illiquid and can be very volatile as investor sentiment shifts during the year, so a nimble trader (or a lucky one) might get an opportunity for a better profit along the way.

The range of possible outcomes is vast, and the extreme outcomes (100%+ gain, 100% loss) are much more likely with call options than they are with simple stock ownership. So when making these kinds of speculative bets, which I do from time to time, it’s critical to think about position sizing. If you typically spend $10,000 to buy a regular position in a single stock, and you tend to be a “buy and hold” investor, then you’re probably expecting that over time, CAT will go up and you can ride the minor ups and downs, and maybe you’re really prepared for a loss of $1,000-$2,000 over time if there turns out to be a real issue with Caterpillar. Maybe you’re even somewhat mechanical about it, and you insist on limiting your losses by selling if the stock hits a certain level, which is called a “stop loss” order. If you would sell CAT if it fell 20%, then, maybe what you’re really willing to lose 100% of is that 20% portion — so perhaps your call option position in a company should be less than 20% of what you would invest in the stock. Just remember that if we happen to have a few soft years in the market, Caterpillar will still be a good company with leading products and will probably find a way to adjust and be relevant five years from now, but if you bet on the stock price moving in a specific year a few years in a row, and you’re wrong, you can easily lose all your money on long-term CAT options even if CAT shares are roughly flat, or even up a little bit, with perhaps some dividend compounding, five years from now.

Phew! OK, we’re finally done. Anyone left? Feel free to chime in with a comment below — have any favorite CHIPS Act beneficiaries? Particular longer-term options speculations you like? Questions about how this all works? Let us know with a comment below.

P.S. We’ve only covered Fry’s The Speculator once or twice, and haven’t heard much from his subscribers — if you’ve ever subscribed, please pop over to our Reviews page to let your fellow investors know what you think about this options trading letter… worth it? Waste of time? Fun read? Great or ghastly picks? Inquiring minds want to know. Thanks!