This is not the old Wall Street anymore. Investing these days, especially in a few extremely hot stocks, requires extensive social media knowledge. You only have to look at the action on Wednesday in the Reddit stocks. Some even doubled in mere hours without any specific catalyst. This is the byproduct of a war going on between hedge funds and Main Street. Both sides are disregarding the rules and the regulators are looking away. Eventually this could cause a breakage in the system and spread damage across other assets.
Meanwhile, the bulls were ripping the proverbial faces of the shorts to shreds. There is no logic to the action. It is a price war delivering extreme profits to some and pain to others. These stocks eventually will revert to trading realities – and they are ugly. I like to root for the underdog because I was long quality stocks like Rocket (NYSE:RKT). It and others like it are inside this tornado catching lift. When the shenanigans end, at least RKT has a thriving business.
Today I will share safe ways to bet that this action will cool. But it’s important to qualify the term “safe” because if it’s truly safe, there wouldn’t be an opportunity for profit. I am using it as a relative term because it involves finite risk amounts and nothing more.
Short the Price Action Regardless of Fundamentals
The ideas today are attempts to short the price action that has unfolded so far. I usually write about upside potentials. But when I see extreme wrongs, I try to game it.
Traditionally, in order to short a stock, investors need to borrow it and sell it. If they are correct and the price falls, then they buy it back cheaper to return the shares. The difference is their profit and they only need to be right once. The problem with this is that it carries unlimited risk. I would never condone shorting stocks using the traditional way. Today, I offer simpler alternatives using basic options strategies.
Since this action is a free-for-all casino, my conviction is weak because I cannot control a coin flip. Logic suggests that eventually reality has to set in. The prices of these hot stocks have to revert to some semblance of value. Current metrics for the tickers we chose today do not make sustainable sense without major improvements. Therefore, the blanket assumption on all three tickers is that as this fad will fade drastically in the coming months.
Trade Hot Stocks Through Options
Usually investors buy put options when they are looking to protect their stocks. But buying them also doubles as a way to short a stock. If the price falls, the value of the put grows. The maximum risk is the price they pay up front and no more. There will be no margin calls and if the stock rallies to infinity, it won’t affect the risk profile. Buying a put spread further reduces the risk but also limits the profit potential.
Why consider buying a spread now? The implied volatility for these hot stocks is at extreme levels. This inflates all options prices, so buying a put spread is the smarter way to go. The spread involves buying one leg and selling another. They are both expensive so they cancel each other out.
I have one last caveat before we start. Shorting one of these hot stocks is risky enough, doing more than one is crazy. They are:
Hot Stocks to Short: AMC Entertainment (AMC)
It is only fitting to start with AMC because it was the star of Wednesday. Watching it rally was incredibly impressive. The thing is going to a zillion dollars whether it makes sense or not. Those who shorted it suffered extreme grief. I respect the price action even though I don’t agree with it.
My opinion does not matter to the price action whatsoever. Eventually, the buying will stop and stocks will revert to trading based on their own merits. Overnight we learned that the company is selling 11 million shares to the public. They confirmed that the action does not reflect reality. I doubt this new breed of investors really cares.
AMC is drowning in $11 billion of debt, versus its market cap that exploded to $30 billion. The math just doesn’t work and I challenge the idea of this being the norm going forward. But if I’m wrong, my maximum damage is the amount I’m paying up front for the debit spread.
For example, I can purchase a September AMC debit put spread for $300 per contract. If AMC stock falls to $40, I stand to make $700 per contract. If price holds up then I’m out my cost and that’s it. This is a viable bet against the insanity. My proposal here may offend the AMC fans, but I will scrub my keyboard with soap after typing this.
My second choice today is the O.G. of the super spikes of late. Tilray (NASDAQ:TLRY) did it first in 2018. GME brought back the concept back to life this year. Yesterday, GameStop stock tested its March spike levels. In fact, it closed highest since February and the bulls are most definitely in charge.
The company reports earnings in early June, so that should add an interesting twist. They could mimic what AMC management did today. The reaction to last earnings was a harsh dip that lasted for a blink of an eye. I doubt that anyone is actually looking for any fundamental information. This is a complete gamble just like the prior opportunity, so I would use the same strategy.
Stocks do not change outlooks this fast. AMC stock did not get 100% better overnight. They say price is truth and I have to respect it. There is something else at play, and trying to game it without bumpers is extremely risky. My strategy here would also be to buy a similar debit put spread for July or longer.
I am not a hater of hot stocks that rally fast. I am picking a fight with a few tickers that have gone way past any logic should allow. Extreme upside without fundamental support doesn’t last. I am confident I’m right but I’m not willing to be unreasonable with my risk.
I respect the buyers for now, therefore, I should limit my risk exposure. There is no way I would give anybody to satisfaction of blowing up my account just to make a point. Time will fix these anomalies because it always does. This is not the first time we’ve had shenanigans and it won’t be the last. There will be lessons for everyone to learn and we will become better traders from them.
Hot Stocks to Short: BlackBerry (BB)
My third bearish picked for today is BlackBerry and it is up in pre-open. Maybe it is benefiting from rotation out of AMC. I remember the days when the catalyst for this stock was its phone keyboard. For the past few years I’ve only traded for technical reasons and to catch surprise spikes. They weren’t as big as what is happening now but significant nonetheless.
Each time they retraced lower very quickly, so they demanded nimble actions. If you didn’t book your profits quickly you missed out. Today, this is my simple thesis for fading the pop and BB stock. I suggested earlier buying vertical put spreads, but this one will be slightly different. What might work better are put calendar spreads.
This involves buying a put out in time, and selling the same level but closer to current date. The differential in duration of the contract causes the put I sell to lose value faster. This has a flare of a thread the needle trade, so it requires a certain level of experience. To be really profitable, put calendars need price to fall but not too fast.
Define Your Risk and Avoid Disasters
The options strategies I shared today seem complicated but they do limit risk. I will close this article by opening the subject for another similar strategy called bear call spread. They don’t need a drop to win, as long as the stock stays below the strike price.
Once this madness abates we can go back to trading these tickers on their own merit. Until then, they are hostage to the rhetoric and the shenanigans. Unfortunately, they involve great stocks like Nokia (NYSE:NOK), Palantir (NYSE:PLTR), and RKT. Investors may want to put these in the penalty box until this whirlwind ends.
Long term good P&Ls will survive. Those last three I mentioned will be higher in the future as long as the stock market holds up. I am a fan of all three of them.
On the date of publication, Nicolas Chahine did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Nicolas Chahine is the managing director of SellSpreads.com.