The “meme stock” madness is back.
The favored stocks of the young traders on Reddit’s WallStreetBets page and Robinhood had been quiet for the past couple of months. But, they sure made a lot of noise last week.
Shares of GameStop (GME) started the week at $156 and ran as high as $215. AMC Entertainment (AMC) ran from $34 to as high as $46. And, Clover Health (CLOV) popped from $7.50 per share to just over $9.
But, it was a newcomer to the meme stock list that provided the most entertainment…
Support.com (SPRT) opened last Monday at $8 per share. It closed at $20 per share on Thursday. Then, on Friday, SPRT traded above $59 before tumbling back down and closing near $26.
There wasn’t any company specific news to explain the wild move – except that some Reddit contributors noted the large 60% short interest in the company’s stock and suggested “this could be the largest short squeeze mankind has ever seen!”
Momentum took over from there… And SPRT, a stock that only has 25 million shares outstanding, traded 166 million shares on Friday.
The action in the options market was even crazier. For example, just to show you how absurd some things are in this market environment…
SPRT closed Friday just above $26 per share. The SPRT September 17 $75 calls closed at $3.20.
In other words, with SPRT trading at $26, traders are willing to pay $3.20 per share for the right to buy the stock at $75 – nearly 200% higher – if SPRT closes above that level three weeks from now.
Of course, anything is possible. It’s possible that SPRT can rally another 200% in the next three weeks. And, maybe those $320 per contract option bets will pay off.
But, is it probable?
I don’t think so.
And, neither do traders of the lower-strike price options…
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The September 17 $30 calls are priced at $8. Buyers of this contract are betting the stock will rally more than 40% over the next three weeks.
That’s expensive. But, it’s quite cheap relative to the premium for the $75 calls.
So, what’s going on here?!
My guess is that novice traders are trying to get into the SPRT trade as cheaply as possible. Maybe they can’t afford to pay $800 for the SPRT $30 call. But, they can somehow put together $320 to buy the SPRT $75 calls.
And, since they’re new to the world of option trading, they don’t understand the concept of “premium decay.” So, they’re willing to pay whatever price it takes to get in on the trade.
No matter how bullish one might be on SPRT, nobody with funds and knowledge is buying the $75 call option over the $30 call at those prices.
And, this situation creates an interesting opportunity to profit if you can think a little creatively.
The strategy I’m about to show you may be above the “approval” level of many subscribers. But, at least you can learn this strategy and once you’re comfortable with it – and understand the risks involved – then you can look for opportunities to use it in the future.
I believe it’s the best strategy to use for trading the meme stocks, and here it is…
The strategy is a “ratio write” or a “ratio spread” – where you buy one call contract and then sell several of another call contract against it.
In this example with SPRT, traders could buy one of the SPRT September 17 $30 calls for $8, and then sell three of the SPRT September 17 $75 calls for $3.20.
The purchased call costs you $800. Then you receive $960 of premium for selling three of the $75 contracts.
So, you actually collect $160 for executing this trade (though, the margin requirement for the uncovered calls on this trade will be about $2000 – which varies by brokerage firm). It’s important to have a net credit on this sort of trade. That way, you can make money if the stock falls.
For example, if SPRT closes below $30 per share on September 17, then both option contracts will expire worthless. And you can simply keep the $160 credit as a profit.
But, you’ll really profit on this trade if SPRT rallies above $30 by September 17. The higher it goes, the better, all the way up to $75.
If SPRT closes September 17 at $75 per share, the $30 call will be worth $45, and the $75 calls will expire worthless. So, you’d have a $4660 profit on this trade ($4500 from the $30 call plus the original $160 credit on the trade).
If SPRT rallies above $75, though, then the profit starts to fall because you’re short three calls and long only one.
But, you’re still profitable on this trade up until SPRT gets above $98 (at $98 on the stock, the $30 call is worth $68 per contract, or $6,800, and the $75 calls are worth $23 per contract – which makes three contracts worth $6,900. Since you collected $160 up front, you could still close this trade with a total gain of $60).
You start to lose money if SPRT gets above $98.30.
Again… SPRT closed Friday near $26. It traded almost at $60 during the buying frenzy last week. Can it get above $98.30 by September 17 – where, at that price, the company will be worth about $2.5 billion?
It’s possible, I guess.
But once again… is it probable?
You have to decide for yourself if you’re comfortable selling uncovered calls – where the higher a stock
goes, the more money you lose – and there is no last number.
If you’re looking to get in on the whole “meme stock” trading craze, though, then a ratio write strategy looks to me to be the best way to do it.
Best regards and good trading,
Will you attempt to use this strategy to get in on the “meme craze” or do you usually stay away from hype trades?
Let us know your thoughts – and any questions you have – at [email protected].