Shares of Gamestop (NYSE:GME) look to have finally found a floor after months of unrelenting selling. Gamestop stock had fallen some 80% after reaching a high near $17 to start the year. Certainly the increased competition from the likes of XBox and Playstation, as well as other online streaming game sites like Stadia, is formidable. The selling, though, has reached an extreme. Time for GME to get it’s game back.
Michael Burry, the noted “Big Short” hedge fund manager who earlier predicted the housing crisis, is building a bullish position in the GME. He feels that Gamestop has a solid balance sheet and will continue to generate enough cash flow to justify a much higher stock price. Mr Burry goes on to say that nearly 90% of Gamestop stores are free cash flow positive. One need only look at the price to cash flow ratio, which is trading at historic lows to validate that assertion.
He sent a letter recently to the company urging them to complete the $300 milion dollar share buyback. He also disclosed that his fund, Scion Management, owns 3 million shares of Gamestock stock — nearly 3% of the shares outstanding. Gamestop stock is heavily shorted with nearly a 60% short interest. This could potentially add fuel to the rally as the shorts begin to get squeezed.
The technicals are looking bullish for Gamestop stock as well. Shares bounced off the $3.15 lows and momentum has just turned positive. GME stock finally broke above the 20 day moving average at $3.65 and looks poised to take out the the 50 day moving average of $4.34 as well. Shares are far from overbought on a 14 day RSI basis. A move to fill in the post earnings gap at the $6 level may be an eventuality.
The option players are beginning to agree with Mr. Burry. Yesterday saw over 15,000 contracts of the September $4 calls trade versus only 2,500 open interest. The 15,000 contracts equates to a potential 1.5 million shares of Gamestop stock. This aggressive repeat buying represents a big bet that the rally in GME stock is just getting started.
More importantly, implied volatility (IV) spiked sharply, moving up from 115 the previous day to nearly 140. This means option prices are comparatively more expensive and sets up ideally for a buy-write, or covered call trade. The trade structure is fairly straightforward, buying 100 shares and selling 1 of the Sep $4 calls for a $3.60 total debit. This captures the rich premium of the options while leaning bullishly along with the big call buyer in a hedged manner.
The buy write is roughly 40 deltas net long — or similar to owning 40 shares of GME stock for each covered call executed. Buying 1000 shares and selling 10 calls would then be equivalent to a 400 shares net long position. Traders may want to sell higher strike calls, such as the $4.5 strike, to obtain a somewhat more bullish position.
Ideally, Gamestop stock closes above $4 at September expiration and the position will be closed at a 11.11% gain in 21 days. If GME stock closes below the $4 strike price at September expiration then one could sell additional further dated options against the stock to reduce the initial $360 net cost by the premium received.
Tim Biggam may hold some of the aforementioned securities in one or more of his newsletters. Anyone interested in finding out more about Tim and his strategies can go to https://marketfy.com/item/options-and-volatility.
