Activision (ATVI) – Calls of Duty

by riskreversal October 31, 2016 12:57 pm • Trade Ideas

Regular readers know that most of our trade/ investment ideas start with something fundamental, usually some sort of catalyst, or relative valuation etc, but we also like to use as many inputs as possible to help formulate a thesis, and we use implied movement in the options market and an underlying’s technicals to help inform options strikes.

Let me give an example. Last week there was a large apparently bullish options trade in Activision (ATVI), from Oct 27th:

When the stock was $44.12 shortly before noon a trader paid 51 cents for the Nov 44.50 / 46.50 1×2 call spread, 7.500 by 15,000

While I have no idea what the trader’s intent was on this trade, or what it may be against, I can glean from open interest that it is likely a trade to leverage an existing long position. I also see that the company is scheduled to report on Nov 3rd after the close, and that the implied move in the options market for the earnings event is about 5.5%, or about $2.50  The max profit in this traded comes at $46.50, about $2.50 from where the stock was when the trade was put on.

I took a quick look at valuation, it’s historical, to the market and peers like Electronic Arts (EA). All seemed pretty reasonable. Then to the price action and the chart. Stock is up nearly 12% on the year, spent the last two months consolidating in fairly tight range near all time highs, and in a fairly constructive uptrend, with no overhead resistance above the all recent all time highs near $46. But then I start drawing some lines, and I only really see risk, sitting right on that uptrend, and below that there is an air-pocket at one year support at $40:

ATVI 1yr chart from Bloomberg
ATVI 1yr chart from Bloomberg

Then, I look at the 5 year chart, the stock’s 70% rally from this year’s lows and I see the breakout this Summer from $40, and its looks like a must hold level on a pull back:

ATVI 5yr from Bloomberg
ATVI 5yr from Bloomberg

The stock certainly acts like something other than a new hit game or console are about to drop, possibly something on a larger scale like a new platform entirely. And that just might be eSports. Watch this report that ran on Fast Money the other night:

And take a look at this story from the WSJ last week: E-Sports: A League of Its Own and this follow-up: 2017 Tech Trends: E-Sports May Disrupt Sports Viewing, with some suggesting that “By 2020, e-sports will make up roughly 10% of U.S. sports viewing,”… “E-sports will reach 88 million fans in the U.S. and 495 million world-wide, exceeding baseball, basketball or hockey, the firm estimates” WOW. You immediately start thinking that the original content creators should and would be the first beneficiaries of such a massive secular shift.

Last week Forbes reported that “Activision Blizzard To Launch Official Overwatch Esports League“:

Activision Blizzard has a smash hit on its hands in Overwatch, the wildly successful first-person shooter game that was released in May. The title’s burgeoning esports presence certainly deserves a decent chunk of the credit for this sustained popularity, and the company is looking to further capitalize by bringing this growing scene in-house.

And we know the trend towards original content, which is why ATVI’s CEO Bobby Kotick, quoted by Forbes via The Street spoke to, and why larger media or tech players might look at gaming stocks a tad differently than they have in the past as strategic assets:

What we’re doing is creating professional content. So we’re organizing around teams and leagues. You will have the Overwatch League which will have a certain number of teams. Those teams will be a combination of professional sports teams as owners and endemic sports teams as owners.

So near term, maybe the stock is a tad extended on the chart, longer term it makes sense to get your arms around just how big eSports could be, what companies and industries it might disrupt, and who the long term beneficiaries might be.

But we started looking at ATVI because of some unusual options activity, considered a bunch of other inputs that led us down a little bit of a rabbit hole that might lead to a short term trading opportunity and a longer term investment idea.

So What’s the Trade?

For the short term trade you’re basically taking a binary stance on how earnings are perceived by investors. In that case defining risk is the main concern, where you can participate on the upside but limit losses below the implied move in case the results send the stock tumbling.

Bullish, Isolating Earnings:

ATVI ($43.30) Buy the Nov 43/48 call spread for 1.55
  • Buy 1 Nov 43 call for 1.80
  • Sell 1 Nov 48 call at .25

Break-even on Nov Expiration:

Profits of up to 3.45 between 44.55 and 48, with max gain above 48

Losses of up to 1.55 between 43 and 44.55, with max loss of 1.55 below 43

Rationale – This trade offers risk reward of 1.55/3.45 on a move higher. It’s break-even on the upside is 44.45 which is more than a dollar lower than the recent high. As far as risk, the 1.55 is more than a dollar less that the 2.65 currently priced in the options market.


Longer Term Investment Alternative

in lieu of 100 shares long of ATVI ($43.30) Buy the Nov4th weekly/ Jan 46 call calendar for.85
  • Sell 1 Nov4th weekly 46 call at .38
  • Buy 1 Jan 46 call for 1.23

Rationale – This sells a call at the implied move (also the previous high) and finances ownership of the same strike call out to January. The ideal situation is a move in line with the implied move, met with resistance at the previous high. At that point the trade would be immediately profitable with the opportunity to make much more after closing and rolling the short strike.


Bearish / Hedge:

ATVI ($43.30) Buy the Nov 43/39 put spread for 1.20
  • Buy 1 Nov 43 put for 1.50
  • Sell 1 Nov 39 put at .30

Break-even on Nov Expiration:

Profits of up to 2.80 between 41.80 and 39 with max gain below 39

Losses of up to 1.20 between 43 and 41.80, with max loss of 1.20 above 43

Rationale – this trade targets a post earnings pullback back to near term technical support just below $40 and defines risk to 2.8% of the stock price.

As always with long premium directional trades into events, you need to get a lot of things right to just break-even, first and foremost direction, then magnitude of the move and of course timing.