Trading Nation

Chip stocks are rallying, and one trader sees a bigger breakout

Here's how one trader's playing a rally for the chip stocks

Chip stocks have gone from hot, to not, to hot again. founder Todd Gordon says the group is on the verge of a major breakout.

"From a technical point of view, the [chips are] just in consolidation, waiting for the next leg up," he said Thursday on CNBC's "Trading Nation."

On a chart of the SMH, the ETF that tracks chip stocks, Gordon notes the formation of an Elliott Wave triangle. This pattern of repetitive trading normally signals that a stock is about to move in the direction of trading prior to an Elliott Wave consolidation, Gordon said.

As a result, Gordon thinks that SMH will break out and rally higher, as chip stocks had seen a big rally that lasted from April 2017 until early February.

Gordon also points out that some of the biggest holdings in SMH, including Taiwan Semiconductor, Intel and Nvidia, look strong, and that's a bullish signal.

To play for a breakout, Gordon likes a call butterfly spread. In this strategy, Gordon is going to buy the October monthly 105-strike call, sell two of the October monthly 110-strike calls and then buy the October monthly 115-strike call. Altogether, the trade costs Gordon $1.33 total, or $133 for the spread.

In this particular trade, Gordon is targeting that middle strike of $110 for the SMH, which closed above $105 on Thursday.