In the lead-up to GameStop Corporation’s earnings report, an intriguing trend has emerged in options trading, with investors notably piling into a contract that stands to profit if the stock surges by approximately 760% over the next six weeks. Specifically, the January 19 $127.50 call option experienced significant activity, changing hands 10,300 times on Wednesday and ranking as the second most popular contract for the day. Remarkably, each unit traded at a relatively low cost, ranging between 7 and 12 cents.
While it might seem audacious to bet on such a substantial rally, the reality suggests a more strategic approach to risk management, especially considering the historical volatility associated with GameStop. The company’s infamous 2021 retail-trading frenzy resulted in a staggering 2,700% surge in share prices within a few weeks.
Investors who take short positions or sell uncovered calls face potential losses if the underlying asset experiences an unexpected upswing. Over the last two weeks, GameStop has seen a gain of around 21%, prompting some traders to take precautionary measures to cap potential losses, even if the threshold set is exceptionally high.
Russell Rhoads, an associate clinical professor at Indiana University’s Kelley School of Business, notes that the recent rally may have prompted traders to hedge existing positions, explaining the interest in the far out-of-the-money call option. Short interest in GameStop has not seen a notable increase in the past two weeks, according to data from S3 Partners LLC, indicating that traders may be utilizing these contracts as a hedge. Approximately 22% of GameStop’s available float is sold short, according to S3 data.
Interest in this particular contract has been building over the past year, reaching around 60,000 total outstanding contracts by the beginning of November. Just ahead of earnings, investors opened up 13,000 new positions, bringing the total to around 70,000. The January 19 $127.50 contract now holds the highest open interest of any option tied to GameStop.
Although some market watchers might interpret the far out-of-the-money call as a bold bet, recent trends suggest a more nuanced strategy. Last week, traders similarly engaged in high-volume trading of a $30 call, implying an 85% advance within days. According to Chris Murphy, co-head of derivative strategy at Susquehanna International Group, some traders may view these calls as an opportunity to profit if the stock and implied volatility rise.
“The buyer might not think the stock will ever go to the strike price,” Murphy explained. “But if the stock and implied volatility go up enough, the trader could sell the contract at a profit.”
