Wednesday, February 3, 2021

You Can Still Trade GameStop (NYSE: GME) Safely, Yield Great Returns And Come Out A Winner

The past week we have seen the likes of GameStop, AMC, KOSS, and a few others dominating the news headline across the market playing out of the short squeeze thesis.

I must say that this has been one of my main sources of entertainment (I believe the same too for others) in the past week, reading across different sources and scrolling multiple forums, understanding what are others are doing and thinking.

The thesis of the Reddit army holding the line in order to cause a short squeeze and not allowing the short sellers to cover back their positions sounds strong enough and valid. Unfortunately, we are in a game of our ownself look after ownself and when there is a group of FOMO people that starts to go in at the later part of the party, there can only be one ending outcome.

Alright, I know it's extremely hard to resist the temptation when you see a 10-year-old kid or a 25 years old student making hundreds of thousands from the trade and become rich overnight. You think your mind can handle the temptation but as you read about how more and more people are making money, you start to think if this is the real deal and if you should "put a foot out to test the water".

Now, Gamestop has dropped by about 70-80% from the peak to close yesterday at $90.

There are a lot of people out there who are still making money out of Gamestop, given they are the early buyers, and are still sitting at a large margin of safety.

There are also a lot of people out there who were burnt by the experience, given that they must have been the late bloomer to the party that was already crowded. Some of these people still believe that things will rebound from here so they continued to hold on to their losses and kept on their beliefs. None of us would know if tonight they'll be right (they might well be right and their actions will be applauded), but they could also be wrong.

One thing I could be sure of is it looks like a sleepless night for many people who were involved in this saga.

For those who are looking to participate in the GameStop trade, here's an alternative option that I think is very safe and still yields great returns. You definitely can't be filthy rich with this choice and appear in the newspaper like the 10 years old kid did, but it's still a very respectable ROI return which can boost and increase your net-worth while being able to sleep very soundly at night (isn't this the most important).

Extremely Safe:

I sold 8 put contracts at a strike price of $3 on a $0.5867 premium with an expiry of 19 November 2021.

Okay, I get it. The expiry does look long for an option trader but to be able to obtain a decent amount of a very deep margin of safety for a strike price of $3, I can only play on the timeline.

If you think about the calculation, that is $0.5867 / $3 = 19.5% return in a span of 10+ months. If you annualized this across the full 12 months, that is in excess of 20% XIRR.

For something relatively as safe as this, I'd rather put my money for a 20% return here than putting my money in high-risk Reits such as LMIRT or First Reit at this point.

Note: The premium has now gone down to only $0.40 when the market closed yesterday, so you can only get a premium of $0.40 on a strike price of $3. That is $0.40 / $3 = 13.3% return in a span of 10+ months, which isn't very bad still.

Still Extremely Safe:

Okay, I know that the November expiry might be too long for a liking so I am also experimenting with the earlier expiry in July with the same variable at play.

This is what I get.

Strike price still at $3 (too safe), Premium at $0.3208 (when I bought), and Expiry on 16 July 2021.

The ROI for this option would be $0.3208 / $3 = 10.7% return in a span of 5+ months. If we annualized this, we are going to get in excess of a 25% return.

That I think is still very safe and way too conservative.

Still Safe:

Okay, the $3 strike price might be too conservative and it may not reflect the true intrinsic value of a company that is turning around.

I played around with the strike price and increase it to $5 this time around, which I reckon is still very safe at this point given the fundamentals of the company (assuming no change).

A strike of $5 for a premium of $0.55 for expiry of 16 July 2021 yields a return of $0.55 / $5 = 11% return in a span of 5+ months.

The incremental increase in the ROI is not significant if you compare it to case 2 but you could see that at a $5 strike price it is still pretty conservative.

As you increase the strike price to $10 and $20, you'll start seeing the impact of incremental value in the ROI but your risk will start to increase.

Final Thoughts

I understand we could take a bit more risk here by increasing the strike price for GME, but what I wanted to point out in this article is that you could still come out a winner with a great ROI even though you are taking a relatively lower risk with selling a put option on GME.

This is definitely better than trying to enter GME at $200 or $300 and trying to bottom fish and double down at $100, not knowing where the stock might go next.

Most importantly, you get a very nice sleep at night.

Thanks for reading.

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  1. Hello B, I have some noob questions

    1) When you sell a put option, that means you have to buy the contract when price hits $3 right?

    2) Do you receive the $0.5867 premium immediately or only in Nov when the contract expires? Is there any additional commission or fee that are payable either to the broker platform?

    3) Is one contract worth 100 shares ... meaning you have to buy those contracts @ $3 x 100 shares should price correct to $3? And your premium received is $0.5867 x 100 shares per contract?

    4) Why sell a put contract and not buy a call contract instead? What's the difference in terms of premiums and risk management?

    5) How do you "position size" your purchases? For example, why sell 8 put contracts not 80 or 800?



    1. 1) When you sell a put, and the price hits the strike price or goes below the strike, you must be ready for the put to be exercised meaning u buy 100 shares per contract u sold, at $3 per share.

      2) Premiums are credited immediately but you need cash as collateral in case the option is exercised. (unless you are on margin) and there are typically commissions charged by the broker for selling/buying options. When the contract expires, you just get to keep the premium.

      3) Yes

      4)Selling a cash secured put means collecting premiums in hopes that the stock will not reach the strike price by expiry. Buying a call is more complicated because you are paying the premium to the call seller in hopes that the price or volatility of the stock will increase more than the time decay of the call. Since there is an expiry on the call option you bought, every day the call loses time value.

      5) That is up to your own risk management. More number of contracts sold would mean more cash as collateral but also more premiums collected.

    2. Thanks GZ for the replies on the queries above.

      Just to add on point 4 and 5, while both selling put and long call are both bullish in nature, the strategy is quite different in the sense for each of them. I think GZ explained it pretty well with the time decay and also your outlook on the company that you are eyeing.

      I'd like to sell as much as possible if cash collateral wasn't an issue unfortunately that becomes an issue once you are constrained with cash (the same way you are constrained with cash buying a dividend company say in sgx), and also sometimes options are not very liquid either so also not easy to get it in huge volume at one go.

  2. This comment has been removed by the author.

  3. Thank you for Sharing! Will try it out one day (with some small amount of spare cash).
    I can see the risk reward advantage if we compare this strategy to the more risky dividend stocks. Using the selling put options could be safer and with better yield.The downside is - it does not have the potential capital gains if stock price increases.

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