Name That Trade – $GME: Play or Get Played

by Dan November 20, 2014 3:14 pm • Commentary

GameStop (GME) reports their Q3 results tonight after the close. The options market is implying a whopping two day move (using Nov 22nd expiration options) of about 10%.  The Nov 44 straddle (the put and the call) with the stock around $44, is offered at about $4.50, if you bought that you would need a move below $39.50 or above $48.50 to break-even.

As I noted on November 11th, in a Name That Trade post– $GME: Getting Played?, GME is cheap:

trades at 11x fiscal 2015 earnings that analysts expect to grow 23% on sales growth of 11%.  The company has a $4.8 billion market cap, and a very clean balance sheet ($193 million in cash, and $214 million in debt), pays a dividend that yields 3.1% and a year ago authorized a $500 million share buyback (here).

Given the recent squeezey action in retail stocks (BBY up 7% today, LOW, TGT, WMT all making new highs this weeks following results) its hard to dismiss the potential for a massive breakout on better than expected news. GME is already approaching key technical resistance at $45:

GME 1yr chart from Bloomberg
GME 1yr chart from Bloomberg

Obviously the stock has come a long way in the last few weeks, up 20% in since October 15th, but with about a third of their float sold short, the potential for a massive move is there. Which is obviously represented from an implied move predicted in the options market that is well north of the average move of about 5% over the last 4 qtrs.

The move in GME options prices over the last month has been quite astounding, with what looks like a fairly steady accumulation of puts with total put open interest more than double that of calls (212,000 to 95,000) with the 7 of the top 8 strikes of open interest puts, with 33k Nov 40 puts, 22k Jan 35 puts, 18,000 Jan 37 puts and 13k Nov 38 puts rounding out the top four.

The one year chart of 30 day at the money IV shows just how much options prices have overshot the levels prior to the last 4 quarters, usually topping out at about 50%, now about 63%:

GME 1yr chart of 30 day at the money IV from Bloomberg
GME 1yr chart of 30 day at the money IV from Bloomberg

So whats the trade??  Last week we looked at a way to fade the high implied move (read here). But after another look I have two points I want to make on why I don’t love that trade anymore. First, the plethora of 6-7% moves by the likes of LOW, TGT & WMT have spooked me a bit, as they are much larger than GME, and there is no telling the sort of short squeeze we could see in this environment on a solid beat and raise.  On the flip side, the 20% one month bounce makes the stock very susceptible to a re-tracement of 50% of the move on a miss and guide lower, despite cheap valuation.

So as always I’ll give my usual disclaimers. For those looking to play an event like this, one with an unusually high implied move, the highest probability of success would be to FADE it.  But for those who like the action of playing directionally, it is important to remember with event trades that you need to get a lot of things right, first and foremost, direction, then timing and magnitude of the move.

Here are three ways to play depending on directional inclination, and a new idea to fade the move:  

1. Bullish – $GME ($44) Buy Nov 45/ 50 Call Spread for 1.35

-Break-even on the upside at $46.35, max gain of 3.65  at $50 or above, about in line with the implied move

Rationale – This is essentially playing for that short squeeze with the potential to double or even triple the money at risk with a move above recent resistance. Obviously the direction needs to be right and that is binary. However, with the high short interest we suspect a move higher could outperform if the news is particularly good.


2. Bearish – GME ($44) Buy Nov / Dec 40 Put Calendar for .85

-Max gain at $40 just above the implied move to the downside, max risk of .85 with large move above or below $40

Rationale – This is probably the best way to set up for any move lower as it takes away alot of the implied vol risk by selling this weeks expiration. A move lower in the stock will likely be met by buyers at some point between the shorts looking to cover and the fact that company isn’t really that overvalued.


3. Neutral Fade the Move – GME ($44) Nov 38 / 44 / 50 Call Butterfly for 2.50

-Break-even on downside at $40.50, and at $47.50 on the upside, lose up to 2.50 between 40.50 and 38 & between 47.50 and 50, max loss of 2.50 below 38 and above 50.

Rationale – This is a fairly high percentage chance of at least making a little money. The maximum payoff is if the stock goes nowhere (which is unlikely) but the break-evens to the downside and upside are about at the implied move levels. This trade actually risks about the same as the iron condor we looked at last week, however the payout for getting it right could be significantly more. The flip-side of that argument is the chances of getting it exactly right are much less than the iron condor.