Electronic gaming has grown tremendously in the last decade, but recently the rate is accelerating exponentially as we see the popularity of e-sports exploding. Apparently, there is enough interest for people to pack arenas just so they can watch other people play electronic games.
Activision Blizzard, Inc. (NASDAQ:ATVI) has been successfully competing in electronic entertainment for a while. Investors love it as evident from its stock setting new highs even after the February correction hit. Unfortunately for the bulls, it wasn’t able to hold it as it has since given back about 15%.
ATVI was due to release earnings after the market close on Thursday. However, due to a mistake by Dow Jones, management was forced to release the report mid-day.
Consequently, the stock was halted but not before it cratered to $64 per share. It closed almost $3 off the low but the technical damage has already been done.
The knee-jerk reaction lower was not due to a bad report. Management beat on almost all metrics. But the initial report was erroneous and created a lot of confusion. Wall Street does not like uncertainty so traders reacted by selling the stock fast.
ATVI beat both on top and bottom lines. They also raised guidance for the full year, but with more weight toward the end of the year than for the next quarter. Meaning that they expect the next quarter to be a little more difficult than previously thought.
In my book, this makes total sense. We are amidst a period of uncertainty for the entire equity market, so management is merely mirroring that fact with their guidance. They basically said that they the numbers will be better than expected for 2018, but there could be a few bumps in the next three months. I could say the same for every stock given the current tariff worries and geopolitical unrest.
Fundamentally, Activision stock is not cheap. It sells at a high price-to-earnings ratio but it’s in line with its competitors. This is a well-run company with very few obvious mistakes in the past. So I have confidence that they can continue to execute on their plans going forward.
Having said that, the technicals are a little concerning. The price action in ATVI stock for the past 10 months has pivoted around the $64 per share Zone. This includes yesterday’s Dow Jones debacle.
Although it is encouraging that the ATVI bulls have successfully bounced off the neckline, it also creates the potential for breakdown. If for whatever reason the bears prevail and breach the solid floor, they will overshoot and could indeed retest $60 or below.
The chart pattern resembles a head and shoulder, which has a bearish outcome if the neckline does not hold. This is not a forecast, but it’s a scenario for which I have to account.
Given the uncertainty that is in the equity markets in general, instead of buying ATVI shares outright and risking $67 per share without any room for error, I will use Activision options to create income out of thin air. In this environment, I have more faith in proven support than upside hope here.
In essence, I will sell downside risk into what others fear and if price holds up above it then I win. Otherwise, I would own shares of Activision but at a much lower price. Using options allows me to build a moat around my risk.
The Trade: Sell ATVI Nov $50 naked put. This is a bullish trade where I collect $1.25 to open. Here I have a 75% theoretical chance of success. But if price falls below my strike then I accrue losses below $48.75.
Selling naked puts is daunting especially during this nervous times. Those who want to mitigate that risk can sell spreads instead.
The Alternate Trade: Sell the ATVI Nov $50/$47.50 credit put spread where I have the same odds of winning but with much smaller risk. Yet the spread would yield 15% if successful.
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Nicolas Chahine is the managing director of SellSpreads.com. As of this writing, he did not hold a position in any of the aforementioned securities. You can follow him as @racernic on twitter and stocktwits.
