New Trade: Gamestop (GME) – Someone Please Cut the Lights

by CC June 7, 2012 1:00 pm • Commentary

Living in the sprawl, dead shopping malls rise, like mountains beyond mountains.
And there’s no end in sight, I need the darkness, someone please cut the lights.   -Arcade Fire

One of our favorite long term topics here at Risk Reversal is the effect the internet is having on bricks and mortar retail. We’ve referred to the troubles at Best Buy due to its status as‘s show room. We’ve talked about about how much shopping we do ourselves online vs. the physical world. I remark that I live in an area of the country with 30 Home Depots and Targets within what seems like 30 miles. This has been covered in the media before so I won’t bore you with the details, but I would only add that I have a theory that the real estate bubble masked a serious sea-change in how we buy things. While developers were taking advantage of free money by throwing up mountains upon mountains of box stores in every new McMansion town in the exurbs, consumers were increasingly changing their shopping habits.

Of all the companies that we could pick on in this area, Gamestop is probably the one that blows our minds the most. This is a company that sells physical versions of a digital product in real estate bubble-ish suburbs and exurbs all around the country.  It just makes sense to us that Gamestop would follow its former foe Blockbuster into the abyss.

Here’s how the chart has held up over the last 5 years:

As you can see, $17 is support going back to 2008, and we think that support will be broken at some point in the next few months.

Probably the best bullish argument for GME is the fact that it has a short interest ratio of 47% of float, so almost half the shares outstanding are being shorted.  That is an obvious source of demand, which is why we’d much prefer to play this with options rather than outright shorting the shares.  We feel better when we look at the top holders of the stock:

The majority of the top holders are mutual funds, index funds, or ETF managers (like Blackrock), suggesting that the majority of its owners are “passive” investors who likely own the stock because it’s in an index or ETF that they track.  That is certainly not a vote of confidence, and that passive supply is likely to increase on any hint of bad news, like the May earnings report.

Now there will be a bunch of people talking about how GME plans to counter the obvious and continue to evolve their business model. I don’t care. As long as they are tied to all of these retail locations they will eventually be done in by the fact that video games can be downloaded digitally from home.

Timing on this trade is hard, and is probably best to time it on up days in the market like yesterday. But I can’t resist. I want to look far enough out to catch what I feel is a story that will only get worse over time. This is a trade I may even continue to roll. So here’s the trade:

New Trade: Bought GME Oct 17 puts for 1.43

We’ll look to spread this trade by selling a lower put on any downward moves in the stock, and could turn this into a long term roll situation if the stock continues to drift lower over time. This option is very thin out in October and has a delta in the 30’s. LIQUIDITY IS HORRIBLE IN THE OPTIONS. This is the type of trade where you don’t want to chase for a fill, we use limits in this sort of thing and wait for the stock to help. This will likely have up days too, and is a long term play, not a quick trade. It’s best to time it on any intra-day or intra-week strength in the stock.