REVEALED: Using Options to Trade Meme Stocks

REVEALED: Using Options to Trade Meme Stocks

Posted On November 4, 2021 12:36 pm

This week, meme stocks re-entered the spotlight amid Bed Bath & Beyond’s (BBBY) secured distribution deal with the supermarket chain, Kroger’s (KR) initial 66% stock surge — with the respective move likely supercharged by a short squeeze as 60% of the float was sold short.

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It dragged some of the original meme stocks back into the mix with AMC (AMC) and Gamestop (GME) jumping 14% and 12% at one point, while secondary names such as Blackberry (BB) and Virgin Galactic (SPCE) got some 5% of love.  Of course, all were accompanied, and most likely turbo-charged, by heavy options activity. Specifically,  YOLO short-term out-of-the-money calls can lead to a gamma squeeze. 

This brings us back to Tesla (TSLA), the oldest, biggest, and baddest of the batch.  TSLA fell into “cult” stock classification before basically inventing the meme game through CEO Elon Musk’s embrace of social media to taunt shorts and pump his stock right to the line of legality.  

Indeed, this week, Poppa Musk created two new meme names when Hertz (HTZZ) announced it had a deal to buy 100,000 Model 3s for its fleet; worth about $4 billion over the next 3 years. It added over $100 billion in market cap to TSLA.  

What makes the options world so special is the ability to capitalize asymmetrically on the euphoric sentiment that’s emphasized by one-sided positioning. 

The best time to buy volatility for a fat tail event is when it’s dirt cheap and nobody wants to touch it. That’s where the true value lies, where everyone is so one-minded in their frame of thinking. 

For selling options, the exact opposite is true; the best time to sell vol is when everyone has just experienced a scare.  The moves in these memes have scared the bejesus out of market makers, hedge funds, and most fundamental-based investors.  This fear translates into an implied volatility increase and what’s often referred to as Volga, or the right of change (gamma) in vega (which itself measures the rate of an option’s value for each implied volatility change.  

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The fact that we now see market players (big and small), learning to run this meme game on dozens of stocks has left dealers and market-makers on high alert.  They are like anxious antelope in that the first hint of an approaching lion of gamma squeeze bolt away. In this case of stock and options trading, that means massive buying and a huge pump in premiums.  

On the surface, it might make sense that the best time to sell premium or short volatility would be during this rush for protection.  But, as we’ve seen, you just don’t know where or when it might end.  If CAR could go up 300%, why can’t it get up to 500%?   

So, during the original GME movie, the options hit a 700% vol reading and tempted many into selling premium.  But in reality, as these events happen with increasing frequency, the best time to sell vol was after the first meaningful pullback.  Let the fear and IV levels calm down a bit.  The market makers are still nervous about the first attack.  Hence, the next time the stock starts moving higher they’ll be ready to quickly hedge and pump up premiums. 

In other words, the best time to sell them was when all the dead bodies were carried out, the stock went flat and MMs were upping the vol on any little 1% upward move that occurred; strictly out of fear. Notice it was the same trade, just applied differently with a different mentality. 

Just as it’s not healthy for your financial well-being to pick a stock’s top or bottom, it’s true with volatility trading too. The best time to sell them was when all the dead bodies were carried out, the stock went flat and market makers upped the vol on any little 1% upward.  If you can focus on areas that experience this same sequence with large frequency, then you can begin to implement a strategy. 

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About author

Steve Smith

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.