Options Trading Ideas in GameStop (GME): a Cash-Secured Put and a Long Strangle
GameStop (NYSE: GME) scored an upgrade Friday morning at BB&T Capital Markets. The firm set a 12-month price target of $32, citing decreased competition in the high-margin market of used game sales. BB&T also noted the retailer’s better-than-expected fourth-quarter results as a positive catalyst. The stock is currently trading near $24.90.
From a technical perspective, GME bottomed out in late February and has rallied 42% in the past seven weeks. It is now approaching the top of its range, so it could be at a critical point. Will the stock break into new-high territory or be rejected at this level? Additionally, earnings are due before the open on May 20 and in three of the past four quarters, the stock has reacted dramatically. Last quarter, the shares jumped 6.5% higher the day earnings were released. In the August quarter, the stock dropped 7%, and last May, the shares plunged 15.5%.
Analysts and stock traders are limited to buying, selling, and holding. Option traders, on the other hand, have multiple strategies to choose from when it comes to planning and executing a trade. Certain option trades benefit from heightened volatility (such as what can transpire surrounding earnings) and others might act at a hedge.
Whether your outlook on GME matches that of BB&T or opposes it, there may be option strategies that can work for the stock. Below are two hypothetical strategies that are not buy-sell-hold recommendations, just educational examples of how one can play the market with options.
*Prices given as of Friday afternoon
Bullish Option Strategy: Cash-Secured Put
Investors who expect GME to continue higher (or at least hold its current level) could sell a cash-secured put. The out-of-the-money May 23 put is currently bid at 60 cents. For every contract sold, the put seller would reserve $22.40 in cash in the event that GME breaches the 23 strike and the seller is obligated to buy the shares.
If GME is still trading above $23 when the put expires in around 35 days, the put seller keeps the 60-cent credit as profit. If GME pulls back, the put seller will effectively buy GME shares at a discount price of $22.40 (the strike price minus the credit collected). At this point, should the trader hold the GME shares, he is exposed to the standard risk of a long stock position – unlimited profit potential to the upside, and significant downside should the shares fall in price. Traders should only sell a put (cash-secured or otherwise) if they would not mind owning shares of the underlying security.
Volatile Option Strategy: Long Strangle
Traders who expect GME to rally or plunge (but aren’t sure which way it might go) could consider buying a long strangle. Since GME reports two days before May options expire, an investor might buy the 23/25 strangle, buying both the May 23 put and the May 25 call for a net debit of $1.95. If GME shares move below the downside breakeven of $21.05 (a 15.4% move) or above the upper breakeven of $26.95 (an 8.3% move), the trade will be profitable. The maximum risk for this long strangle is 100% of the debit paid, which the buyer surrenders between 23 and 25. Gains are unlimited if GME moves higher and significant (limited only by the zero mark) if the stock declines.
Your thoughts?
What’s your take on Gamestop’s fundamental and technical backdrop? And how do you think earnings will play out? Let us know in the comments below.
Compare OptionsHouse rates for stock options with other brokers. For investors who are new to options and want to try out their trades without committing real money, practice using a free virtual trading account.
Photo Credit: moe_
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