There is an old saying among commodity traders that the cure for high prices is high prices. A veteran options analyst argued that the same will be true for GameStop Corp. options. and other high-flying targets that have become popular on Reddit message boards.
The idea is just Econ 101: as wheat, oil, or gold prices rise too much, users naturally use less of the product. As demand is rationed, prices end up declining (the same idea works the other way around, with low prices seen as the cure, of course, for low prices).
And so it could be after last week’s frantic buying of stock options, which give the holder the right, but not the obligation, to buy the underlying value at a set price at a given time, at GameStop GME,
and shares of other companies with a strong short-range, Julian Emanuel, chief strategist at BTIG shares and derivatives, said in a note Sunday.
Strong call buying was part of an effort by an army of individual investors organized through Reddit’s WallStreetBets forum to drive up very short corporate prices, forcing short-term sellers to recoup their shares. and accelerating concentration. Call buying generated its own feedback loop, as market makers, who had sold call options, bought the underlying shares to hedge or neutralize their market exposure.
More details: As a options trading frenzy it raises stocks and causes fears in the market bubble
The strategy, like anyone who paid the least attention last week to the markets or the news, seems to have worked pretty well. Shares of GameStop shot up 400% last week to end at $ 325 on Friday after hitting a close to about $ 500 on Thursday. GameStop ended in 2020 about $ 18 per share.
Read: GameStop short squeeze feeds new stock services that track Reddit messages
Given these rounds, the implied volatility (a measure of the cost of an option) at 1,000% off the charts, turned out to be cheap for options that expired last week, said Emanuel, who pointed to the chart less than the 3-day volatility increase.
BTIG
But there is likely to be a different story in the future, he said, arguing that options “have probably become too expensive to continue to be a source that would feed even higher on several meteoric winners.”
To illustrate, he noted that an option to buy on demand (one with a strike price equal to the share price) on GameStop that would expire on February 19 cost about half the actual price of the shares. GameStop, or 580% volatility. In comparison, an effective call to the S&P 500 SPX,
it would also expire on Feb. 19 and cost 2.5 percent of the real index price, or 26.5 percent volatility, he said.
Since both options were monetary, they had no “intrinsic value,” a measure of the profitability of the option based on the strike price relative to the share price. Instead, the premiums consisted entirely of a “temporary value,” based on the expected volatility of the underlying asset and the time until the option expires.
The share of GameStop fell 27% on Monday, while the Dow Jones Industrial Average DJIA,
it rose 300 points, or 1%, and the S&P 500 advanced about 1.8%. The main benchmarks recovered some of the ground lost in the worst weekly fall since October, a decline attributed in part to hedge funds and other investors who reduced long positions and reduced short positions.
The bottom line, Emanuel said, is that GameStop’s options and much of the cohort of speculative stocks fueled by GameStop’s social media “now have very expensive options, perhaps prohibitively.”