Chart of the Day – GameStop (GME)

by riskreversal November 22, 2016 2:01 pm • Chart of the Day

GameStop (GME) will report their Q3 results tonight after the close. The options market is implying about a 6.75% one day move tomorrow, which is above the 4 qtr one day average move of 4.8% and the 10 year average of 5.5%. With the stock near $24, the Nov 25th weekly 24 straddle (the call premium + the put premium) is offered at $1.65. If you bought that, and thus the implied move you would need a rally above $25.65 or decline of $22.35 by Friday’s close at 1pm.

The implied move seems a tad hefty when you consider the company already pre-announced the quarter and guided down for the balance of the year on Nov 2nd and declined 11% the next day, per Barron’s Online:

GameStop said it expects to earn between 45 cents and 49 cents a share in the third quarter, down from a previous range of 53 cents to 58 cents, and below the 57 cents analysts were expecting. It sees revenue of about $2 billion, just below the $2.1 billion consensus estimate, and expects same-store sales to fall between 7% and 6%, from previous guidance of a decline to 2% to 1% growth.

The company also lowered his full-year view, down to earnings of $3.65 to $3.80 a share (it previously said $3.90 to $4.05 a share) below the $4 consensus.

What’s interesting about the stock’s post earnings drop is that it went down but didn’t stay down, which may be related to the stock’s 25% short interest. At fresh 52 week lows after an unexpected negative announcement often times you seeing selling become exhausted and shorts start tripping over one another to cover and take profits.

Prior technical support at $25, now becomes resistance:

[caption id="attachment_68365" align="aligncenter" width="600"]GME 1yr chart from Bloomberg GME 1yr chart from Bloomberg[/caption]

GME is a cheap stock, trading 6.4x expected fiscal 2017 eps. The company trades .3x its expected $9 billion in sales, which is not far below its peak sales in f2012 of $9.6 billion with eps very near their peak of $3.90 in f2016.  So what’s the problem? Like most brick and mortar retailers, maybe?

The stock probably has healthy support at $20, it would take another miss and guide down just weeks after the Nov 2nd one to cause that to happen.

On the flip-side, if the company is able to look past fQ4 and offer positive outlook for f20108 then the stock is easily through $25 and possibly back towards $20, the next cluster of technical resistance.  The main point is that sellers probably become exhausted again near the prior low, while buyers include shorts and potentially value buyers.

So What’s the Trade?

For those looking for stock alternatives to play for a post earnings short squeeze, one way to do that is through a risk reversal, where post earnings movement inline with the implied move isn’t of too much concern, but offering leverage for a squeeze higher (and a breakout above resistance):

GME ($23.60) Buy the Dec 21/25 risk reversal for 0.10
  • Sell 1 Dec 21 put at .35
  • Buy 1 Dec 25 call for .45

Rationale – This position if only for those willing to be put the stock below 21. The long term story for GME isn’t great as they’re in a particularly difficult segment of retail, competing with both physical games sold online as well as digital downloads. But that story is well known, as reflected in the massive short interest. The slightest bit of good news could squeeze those shorts. So this is for people willing to bottom fish below 21 and who want to be there on a squeeze above 25. Anything in between (the most likely odds and the position costs .10 for the look).

This is not exactly our cup of tea, into an event like this, but we prefer a trade structure like this to buying stock given the skew in short dated options.