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How to Use Options to Play the Big Dip in AMC

The mania surrounding AMC Entertainment has cooled this month. Some would say it was inevitable, a byproduct of prices becoming unmoored from reality. Not that all the insanity has been rooted out, mind you. AMC stock is still up an incredible amount from its sub-$2 share price.

Neon sign of an AMC (AMC) theater
Source: rblfmr / Shutterstock.com

But, at least some of the froth has been removed. At Thursday’s lows, the struggling theater chain was 56% off its highs.

We’ll unpack the numbers further below with the intent of helping you make a more informed decision on two essential questions. First, should you buy the dip in AMC stock? And second, should you buy now or wait?

To set the stage, let’s first consider what’s going on in the broader market and how it’s playing into the AMC rug pull.

AMC Stock and the Market Backdrop

While the mega-cap indices continue to bask at or near record highs, the underbelly of the market has been getting torched. Pot stocks, meme stocks, momentum stocks, high-beta, small-caps – take your pick. The lot of them have reversed into downtrends, some aggressively so. There’s a message being broadcast amid the destruction. Risk appetite is waning.

The reversal of fortune has multiple causes. Seasonality is one. The summer months are renowned for their choppy, dithering nature. Many a correction have struck equities during this time of year. A second cause could be that the blistering pace stocks set for the first half of the year – particularly in the land of small-caps – was altogether unsustainable. Some backing-and-filling or giveback is understandable after prices rise into orbit.

With this as the backdrop, caution for bottom fishing in the likes of AMC stock is warranted. I tend to favor higher probability, more conservative trades after such a dramatic decline over aggressive directional plays. This logic will play into my suggested trade below.

AMC’s Stock Chart

AMC stock weekly chart with retracement
Source: The thinkorswim® platform from TD Ameritrade

I’m starting with the weekly chart to remind you just how explosive the recent rise was. AMC troughed at $1.91 earlier this year before finding favor with Reddit and getting caught up in the meme stock mania. Its first short squeeze jammed prices up over 10x to $20. The next one came at the end of May, creating a parabolic move to $72.62. From trough to peak, the price gain was 3,700%. So naturally, the popularity of the stock and the attention garnered exploded along the way.

Over the past month, the inevitable rollover has arrived to give back half of the otherworldly gains. However, we’re still well above the 20-week moving average and any other potential support zone on the weekly time frame. So to better tackle the question of whether buying the dip is wise, we need to drill down to the daily chart.

AMC Stock daily chart with deep correction
Source: The thinkorswim® platform from TD Ameritrade

The magnitude and speed of May’s explosion left little by way of potential support zones for future retracements. For that reason, there aren’t any previous price pivots or congestion areas between $15 and $40. Gauging when to buy the dip then becomes largely a matter of guessing if AMC stock is oversold enough to justify a purchase. Being 50% off the highs certainly makes it tempting.

At a minimum, I would wait for confirmation that buyers are returning. Look for prices to break above a prior day’s high to reverse the current downswing. Today’s 7% rally is a start, but we’re still below the 50-day moving average and Wednesday’s high.

Short Puts to Elevate Your Odds

The sky-high implied volatility makes selling premium extremely lucrative if you’re on the right side of AMC’s wild moves. It also makes it easy to build a high probability trade with plenty of margin of error if prices continue to unwind. Since the next major support zone isn’t until $15, I want to enter a trade that profits as long as the stock is above $15 at August expiration.

The Trade: Sell the August $15 put for $1.00.

The short put obligates you to buy 100 shares at an effective purchase price of $14 if the put sits in the money at expiration. If it doesn’t, you’ll capture $100 per contract.

On the date of publication, Tyler Craig 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.

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Article printed from InvestorPlace Media, https://investorplace.com/2021/07/how-to-use-options-to-buy-the-big-dip-in-amc-stock/.

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