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GameStop (GME) Attracts Short-Term Optimists

Options speculators buy a short-term bull call spread

by 6/7/2012 12:19:22 PM
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GameStop Corp. (GME - 18.98) has lagged the S&P 500 Index (SPX) by almost 15% in the past three months. The stock even lost ground on Wednesday while the broad market was enjoying its best day of 2012. Despite this underperformance, option players are projecting more upside in the retailer.

In early trading today, blocks of roughly 8,800 contracts traded on both the July 20 call and the July 24 call. The 20-strike call options changed hands at $0.89 apiece and appear to have been purchased while the 24-strike calls were evidently sold for a credit of $0.15 each. The resultant bull call spread traded for a net debit of $0.74 per spread. Implied volatility has risen on the 20 call and dropped on the 24 call, further validating that the former was bought while the latter was sold.

With GME shares trading south of the $19 level, this is a fairly aggressive play, as it loses 100% of the debit paid if the shares are trading below $20 at July expiration – in 43 days. The maximum profit of $3.26 is achieved if the stock rallies all the way through $24 by the time the options expire. Breakeven on this trade is $20.74, meaning GME has to appreciate roughly 10% between now and July 20. The combined delta on this spread at the time it hit the tape was 39.7%, revealing a less-than-40% chance the spread will be in the money by expiration.

Profit/Loss Chart of GameStop bull call spread
Chart courtesy of OptionsHouse

Overall call volume is running six times the norm today while put volume is two times above average. A block of nearly 4,000 July 16 puts traded for $0.18 each this morning. While volume easily trumped open interest, indicating buyers were at work, the price crossed the tape out of sequence, making it hard to determine whether the puts were on the buy or the sell side.

Despite a slight pop higher earlier this week when Microsoft (MSFT - 29.42) said a select number of GME stores would be selling Xbox subscriptions, GME has been struggling on a technical basis. The stock has been wrestling with resistance from its 40-month trendline (at $22.73) since late 2008, peeking above it a few times in the past 12 months before recently making a definite move south. The shares have also faced short-term resistance in the form of their 40-day trendline, which rebuffed the stock's May 30 advance.

Monthly

Meanwhile, option speculators could hardly be more supportive. In the past 10 days at the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), a whopping four puts have been bought to open for every 100 calls. The buy-to-open put/call volume ratio of 0.04 stands at an annual low, suggesting the option crowd's appetite for bullish opportunities is hearty.

Analysts are relatively supportive of GME as well, as evidenced by seven ratings of "buy" or better along with nine "holds" and a single "sell." This is a slightly more pessimistic landscape from a month ago, when there were eight "buys" and six "holds."

If this positive support begins to unravel, in the form of downgrades or increased bearish speculation in the options pits, GME could face additional headwinds, increasing the risk to today's call spread buyers.

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