Fast query: In July of 2021, do you suppose GameStop (NYSE:GME) inventory might be buying and selling above or under $20 per share? For a fast trace, shares are at present buying and selling round $245. Moreover, GME inventory has been at or above $20 for all of 2021. It spent only some days under $40, in reality.
But, within the choices market, there’s a approach to make a wholesome return merely if the inventory stays above $20. That’s although GME inventory solely crashed again to $4o or so even on the depths of its February pullback.
In any case, right here’s an effective way to revenue from GME’s inventory worth staying comparatively elevated, even when shares descend sharply from their present triple-digit ranges.
Some Merchants Suppose GME Inventory Will Drop 93% Quickly
Again to the opening query: What odds do you place on GME inventory being beneath $20 inside 4 months? Fairly low, proper? But, persons are at present paying $2.00 per option contract to guess on GME inventory dropping under $20 by July of this 12 months. Should you suppose GameStop will keep above $20, you’ll be able to benefit from that worry and promote $20 naked put options to the hyper-bearish merchants.
For the put purchaser simply to interrupt even, they would wish GME inventory at $18 by July. To double their cash, it must go to $16. And so forth. We’re speaking an enormous decline right here. Even when we assume that GameStop will drop 50% or 75% between every now and then, it wouldn’t even come near hitting $20.
As a reminder, GameStop hasn’t been under $20 in months, and since then, it has attracted a big retail fanbase. This may hold the inventory from sliding extra rapidly, as many shares are held by so-called diamond fingers.
Why Hasn’t GameStop Raised Cash?
On high of that, right here’s the near-term catalyst. GameStop hasn’t raised any cash since its inventory went to the stratosphere. This has appeared inexplicable. With GameStop pivoting its enterprise mannequin to digital-first, it will need to increase additional cash.
With the inventory at $275, it’d be loopy to not situation inventory right here. Promote a mere 6.5 million shares at $275 and you’ve got almost $2 billion in proceeds.
That might make sure that GameStop survives for a few years. And the corporate has 65 million shares of inventory as is, so 6.5 million shares is hardly any dilution, simply 10% of the overall inventory. And, right here’s the enjoyable half, even post-dilution, GameStop’s share base continues to be sufficiently small that that $2 billion in money quantities to $27/share. That’d be a tough ground for the inventory worth.
Why hasn’t GameStop issued inventory up to now? In late January, it appears the corporate couldn’t situation inventory as a result of it had preliminary gross sales information it hadn’t launched but.
Then, GameStop’s CFO left. Understandably, an organization wouldn’t need to situation inventory when its CFO goes away. That’s asking for hassle. And now GameStop has earnings developing on March 23. Once more, it’d be questionable to situation inventory proper forward of an earnings launch.
GameStop Will Lastly Elevate Capital Now
All that to say that, remarkably, GameStop has arguably not had a 100% clear window with which to situation inventory since its share worth went parabolic.
The upcoming earnings report, on March 23, can be pretty much as good a time as any to do the share issuance. While you launch the numbers and have a convention name, everybody has equal info. There can be no foundation for authorized complaints about issuing overpriced inventory.
If and when GameStop points inventory on or quickly after March 23, I consider the July $20 places go to virtually zero shortly thereafter as folks will see the massive money steadiness and say, “Nicely, there’s no manner the inventory will completely crash now.” That might generate a fast revenue for the put sellers.
Why Are GME Share Places So Costly?
The reply is that when implied volatility goes up (resembling it’s proper now) each name and put implied volatility go up roughly equally. Choices are priced on the idea that shares have a comparatively regular distribution, i.e. their strikes fall alongside one thing resembling a bell curve.
Factor is, in excessive situations (resembling GameStop), this logic breaks down. GameStop can simply go up greater than 100%. In the meantime, in actuality, a inventory can’t go down greater than 100%.
But the pc fashions that decide market maker possibility pricing increase the worth of places together with the worth of calls as total volatility will increase.
Nevertheless, the percentages of GameStop really failing aren’t going up. The truth is, it’s the other. GameStop can increase capital extra simply, and it’s attracting extra retail shareholders who will maintain the inventory for an prolonged interval.
Every single day GME inventory spends up right here at an inflated worth, the extra unlikely it turns into that the inventory crashes again to a sub-$20 worth. But places are nonetheless priced as if imminent collapse is probably going.
July $20 Places: Ridiculously Mispriced
This brings us to the July $20 put. Again in January, with the inventory round $40, this feature was round $4.75. That was when the choice was solely $20 out of the cash and nonetheless had six months of length left.
Hilariously, as GME inventory spiked to $500 the primary time, the choice really went as much as as excessive as $8. This was completely nuts. In fact, the percentages of GME ending up beneath $20 didn’t improve because the inventory worth went up 1000’s of p.c. However choices are priced by laptop and generally the computer systems are out of their ingredient.
By mid-February, GME inventory was again right down to $40. But the put declined in worth. Sharply!
Even because the inventory dropped 90%, the $20 put possibility fell from that peak of $8 to only $3. As volatility plummets, the worth of manner out of the cash places additionally collapses.
With the most recent run-up in GME inventory from $40 to $300, the July $20 put has barely moved. It’s solely slid to $2 from its earlier $3 stage even because the inventory went up 700%.
The Backside Line
GME inventory is wildly overpriced proper now. I wouldn’t need to personal it at in the present day’s costs. Nevertheless, resulting from excessive implied volatility, choices are additionally far too costly on GME inventory. Therefore, the chance to quick $20 places and make $2 per contract in simply 4 months. That’s a ten% return on money in 4 months, or greater than 30% annualized.
At worst, if GameStop does collapse between every now and then, you’d get exercised on the place at an efficient price foundation of $18 per GameStop share. On condition that GME inventory is at present at $275, proudly owning it at $18 would hardly be the top of the world.
When markets malfunction, it creates alternative. On this case, whereas GME inventory is much too risky for a lot of merchants to deal with, its far out-of-the-money places have created a beautiful set-up to generate option-selling revenue.
On the date of publication, Ian Bezek held a bullish place in GME inventory through July $20 strike GME bare places. He held no direct place in GME frequent inventory.
Ian Bezek has written greater than 1,000 articles for InvestorPlace.com and Looking for Alpha. He additionally labored as a Junior Analyst for Kerrisdale Capital, a $300 million New York Metropolis-based hedge fund. You’ll be able to attain him on Twitter at @irbezek.