Options Trading: This Stock is Ready for a Short Squeeze
By: Steve Smith
Earlier this week I highlighted how bears were making money shorting stocks. But short selling can be a dangerous game, as you’re always at risk of a short squeeze inflicting large losses.
A short squeeze happens when a stock has a large portion of its float sold short. Remember, every share sold short is like an embedded buyer, as those shares will eventually need to be bought to close the position.
If the stock price begins rising for one reason or another the people who are short maybe be forced to buy to cover or close their positions as they need to limit losses or get a margin call from their brokerage firm. This in turn drives the price higher, forcing even more short covering and before you know it the squeeze is on.
I think Gamestop has multiple pieces in place for just such a squeeze to take place in coming weeks.
- Fundamentals: People have been predicting the death of Gamestop for over a decade, basically assuming it will meet the same fate of Blockbuster or other physical/mall-based retailer whose product can more easily purchased online.
- But a few things that have allowed the GME to defy the odds; it has retained a lock on the profitable, albeit shrinking, used game resale/trade in segment. It’s created a more interactive experience in the stores encouraging young gamers to come and hang out. It’s successfully growing its digital/online sales and lastly, it has a rock solid balance that allows it to pay a dividend of $1.52 per share, which currently equals a 10% yield.
- Technical/Chart: In September, the stock quickly recovered from a sharp sell-off and in the process broken a long-term downtrend. It has now consolidated into a bullish wedge at the $14.50 support level. It looks ready to move higher.
As mentioned above, there is an extensive history of people who believe the company is going to be ‘Amazoned’ out of existence. This has created large short interest with over 32% of the float sold short. This creates the possibility for a squeeze.
To profit from a potential for a short squeeze I want to buy calls outright. This will give us the full leverage and ability to exit for maximum profit at any point prior to expiration:
I’m buying the October (10/19) 14.5 calls for around $0.50 each.
I have a price target of $16.5, which would give the calls a minimum value of $2 for a 150% gain.
Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.
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