Potential Trade (GME) Breakdown : Short Put

In my weekly tracker I talked about selling an out of the money put in GameStop and I wanted to make a dedicated post to the topic to explain in further detail.

So as of now GameStop is trading at $325 at close on 1/29/21.

I was looking at the $16 Strike Price Put with an expiration date of 2/12/21 (around two weeks away from this post) that is selling at $80 right now. The dynamics of selling a put means that I have the obligation to buy 100 shares of GameStop at $16 if the buyer of that option decides to exercise. This is bullish play with defined risk. The max loss would be if GME went to $0 in the next two weeks.

The current implied volatility in GameStop for this expiration is over 700%, which really means this stock is expected to nosedive or keep pumping. That is what the options markets are pricing, but my belief is that the downside in the short term would be met with buyers at certain price points. 

Don’t get me wrong, is GameStop worth $325/share or $23 billion in market cap? I don’t think so. Will the stock be volatile these next couple months? Absolutely.

But do I think the stock will crash over 95% in the next two weeks? No. That’s right a crash of 95% gets you back to around that $16 strike and I would still keep the premium at expiration. 

Before the short squeeze was mainstream and everyone at work was talking about GameStop at the water cooler, it traded around that $15 to $20 range. The 200 DMA is around $15, so even if it pulls back it would have to do it in two weeks time.

The break even on the trade would need to have the stock at $15.20 by 2/12/21. Any further than that we would have losses. At any point the implied volatility contracts we make money, if it goes higher we make money, if it crashes but doesn’t get absolutely wrecked we make money.

Obviously it’s not 100% and there is risk to the downside. But when you look at the trade it offers a .01 delta option that locks up $1600 and a max profit of $80. That is a 5% return over 11 DTE if we put it on Monday. Meaning the annualized return is 166% (0.05*365/11). Not too shabby.

So this is one way to get involved with the craziness without going out and buying it at $325 and hoping it continues to squeeze and hope it doesn’t crash. In this case we have a calculated bet with a decent risk/reward. Am I going to bet the house on this one trade? No. I never do with any one trade. As risk management should always be the first thing that comes to mind.

Let’s talk about why I see this as the only rational play in GameStop at this point. Everyone expects the stock to tank or explode higher, so the implied volatility is crazy high. So at this point buying options is insane as you have to be right in both direction and timing and you need a massive massive outlier move. Do I want to sell calls on this stock? No way as the squeeze could potentially continue and losses are potentially unlimited. Therefore selling puts makes the most sense to me because we make money even if the stock comes back down from the moon.

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