Will the Bleeding End for Cree, LED Stocks?

Wunderlich's O'Neill says that thinking of Cree in terms of the LCD TV backlighting market isn't the full extent of the outdated thinking about the LED stock. In fact, the analyst argues that thinking of Cree as being tied to the cyclical ups and downs in the semiconductor sector is a theory that is running out of support. It may be correct for right now, but it's a trading dynamic set to change sooner rather than later.

The Wunderlich analyst conceded that in the next six to 12 months, there is a fair chance of a traditional cyclical slowdown in semiconductors. What's more, O'Neill says that analysis of Cree trading patterns show that the stock has moved in line with the sentiment in the semiconductor space.

Wunderlich Securities' analysis of Cree's quarterly revenue data from 2006 to 2010 shows what the analyst described as a remarkably high correlation between Cree revenue and semiconductor sales. Still, Wunderlich estimates the percentage of LED-backlit LCD monitors and televisions as 12% of the market, and if the business were to disappear, it would impact Cree's EPS by less than a dime.

The larger argument for Cree bulls is that beginning in 2012 incandescent light bulbs will no longer be sold in the U.S., and LED lights are poised to become the standard replacement. For all the bearish talk that the future for Cree is uncertain, the Wunderlich analyst says that this sea change in lighting is just 15 months away. Home Depot (HD-NR) is already carrying Cree lighting products and Cree-equipped lighting. In this scenario, Cree is no longer a semi-linked stock -- rather, Cree revenue will become more closely correlated with consumer staples.

If that's to the reason for Cree's rise in the long-term, the consumer staples argument for Cree wasn't holding sway on Thursday and Friday, as Cree shares kept heading lower, slipping below the $50 mark. Cree wasn't just down on Thursday; it's trading volume was also twice its daily average.

Options trading analysis also indicated that the bleeding in Cree shares might not immediately end. An analysis by OptionsMonster showed Thursday's Cree option volume at more than three times the average and almost 2:1 in favor of the puts. In one October put trade referenced, the net cost of $1.14 is the maximum risk in the trade and would be lost if Cree is above $45 at expiration. If shares are below $40, the maximum gain of $3.86 would be realized. The only other time this year Cree saw the $40 level was on the way up to its high of $83.

The options web site wrote it's possible that some of the action was a protective trade on a long stock position, but that would seem to be a very limited hedge, leading to the conclusion that the Cree action on Thursday was a straight bearish bet.

>>Cree Draws Bearish Options Trade

-- Written by Eric Rosenbaum from New York.

RELATED STORIES:

>>Cree Selloff is the Beginning, not end of Debate

Follow TheStreet.com on Twitter and become a fan on Facebook.

>To order reprints of this article, click here: Reprints