GME was a stock that we traded on the short side near the end of 2013, mainly with a technical view that the stock had broken down below important support in the $50-$51 area, so we were looking for a move back down to the mid-40’s. We did get that move in early December, and took the trade off for a nice gain.
Since then, the stock rallied up to the rising 50 day ma and that horizontal support around $50-$51, before falling after Christmas:
Aside from the technical overhang, we’ve been watching the GME fundamental story quite closely for the past 3 months, since the holiday season accounts for 65% of GME earnings, and is thus crucial to the stock’s long-term prospects. GME analysts and management have identified the new console cycle (PS4 and Xbox One) as the catalyst of strong earnings growth in 2014 and 2015.
However, I outlined my skepticism of that view in our Deep Dive post about 3 months ago:
Reading the rest of the 10-Q, you get the sense that this is a declining company. Net sales across all its major categories have declined 5-25% over the last year. The company has been in cost cutting mode, so its net profit has only declined about 5%. But GME management simply blames the sales decline on the fact that we are in the late stage of the console cycle. Management does acknowledge that digital delivery of games is the wave of the future, but lays out little besides standard, cliched lines about “new investments” in the digital space.
Analysts have modeled in modest profit growth over the next couple years, clearly expecting a pick up in sales when the new console cycle gets underway. The Playstation 4 and the Xbox One are both going to be launched in the next few months, just in time for the 2013 holiday season. Interest in video games is expected to increase, and GME management is confident that it can cash in on that excitement.
Well, we’re now through the holiday selling season, and we have a few data points so far. First, MSFT Xbox One sales are weak. MSFT was down 2% yesterday on decent volume after disclosing 3 million Xbox One sales so far, BUT noting that console sales have already slowed down significantly after the initial excitement. Given that the release was less than 2 months ago, that’s quite a concerning sign for a new console cycle.
Moreover, the weak holiday sales results from HGG yesterday, which also hit BBY stock, could be another indication that electronics demand for the crucial 4th quarter might miss estimates. Now, it’s worth noting that GME has likely benefitted quite a bit from the strength in Sony PS4 demand, which looks to have done better than the Xbox One. And short interest in GME is still at 20% of the float. But the technical and fundamental situation are concerning for the bulls here.
My hunch is that the actual sales season was not necessarily bad. My real concern is about the future console sales after the initial excitement from the hardcore gamers. As a result, I don’t want a position focusing solely on the event next week, but since the options market is pricing in high volatility in January and much lesser in Feb, there’s an opportunity to place a position before the event that still gives the whole situation a little time to play out. Here’s the trade:
Trade $GME ($48.80): Bought the Jan18th/Feb 46 put calendar for .70
-Sold 1 Jan18th 46 Put at .85
-Bought 1 Feb 46 put for 1.55
Break-even: The ideal scenario is that GME closes at $46 on Jan18th expiry, so that the Jan short put position expires worthless, and the Feb long put position is in its sweet spot. At that point, we might look to spread the long Feb put or take it off. The put calendar will likely be profitable if GME is between 43 and 49 on Jan18th expiry (depends on what happens to Feb vol), so this is still a short-biased trade, but our upside risk is only our premium at risk of $0.70, with the thought that GME will have a hard time getting above $51, even on good news.
Rationale: The implied move for GME on next week’s sales release is around 7.5%. Since it’s clearly expected to be a big move, the calendar position could be a loser with a large move higher. We don’t want to risk losing all of our premium on one event, so we’re positioning this as a calendar, as well as the fact that we prefer the risk/reward on a structure like this rather than those simply outright short the stock. The 200 day moving average comes into play around $45, which is also where the stock recently bounced. Any move towards 46 into January expiration is the ideal spot for this structure. January vol will get crushed after the event with February only falling about 5 points or so.