Current Price: $7.6
Expected Price: $0
Upside: 100%
Expected Closing: 18 June 2021
This is a very risky trading idea that involves selling options (far out-of-the-money ones). This is not an investment advice. Do your own due diligence before investing to understand full risks involved. Max upside is 100% while the downside is unlimited and could be multiples of capital deployed on this trade.
With the disclaimer out of the way, here comes the investment/trading idea.
Due to the recent spike and increased volatility of AMC shares (google it, plenty of front-page news coverage), option premiums reached stratospheric levels even for near-term expirations. In a way, today we have a replay of end-of-January situation when GameStop and a number of other stocks (including AMC) got temporarily squeezed by retail investor driven by WallStreetBets and Robinhood crowds and option buying craziness.
AMC call options expiring on the 18th of June (i.e. only two weeks from now) with an exercise price of $145 (way out-of-the-money or 3x above the current price) are trading at $7.6/share. Investors can pocket this whole premium by selling the respective call options if during upcoming two weeks AMC shares do not trade above $145/share. These options have traded as high as $16/share yesterday and will likely remain volatile. Other expiration dates and exercise prices should work-out equally well if AMC stock returns to normality in the coming days/weeks.
Scenarios for the next two weeks – the third one is the key one to consider:
- AMC shares remain below $145 – options will expire worthless and call sellers will retain 100% of the received premium.
- AMC shares trade in the range of $145-$153 – the options get exercised and the upside is reduced proportionally.
- AMC shares trade above $153 (i.e. AMC market cap of $75bn!!!) – calls get exercised and call sellers lose the whole received premium and potentially multiples more.
I find it also very interesting that the difference in option premiums for calls with $100 exercise price ($10.5) and $145 exercise price ($7.6) is minimal – i.e. the market views the probabilities for AMC stock doubling or tripling from the current levels to be of the same order of magnitude. Exciting times we live in.
What is happening with AMC stock?
The spike in AMC shares has been widely covered by news media. The background story is the expected recovery in the movie theater industry after 1.5 years of covid lockdowns. Retail investors picked this up and started pushing the stock. Here is AMC ticker sentiment on WallStreetBets – over the last week almost 50% of the board’s activity was on AMC stock.
On top of that AMC’s CEO Adam Aron started welcoming and embracing the newly minted shareholders. His Twitter account does not seem to be that different from the WSB board itself. Apparently, most of AMC stock is now in retail investors’ hands. From Q1’21 conference call – 7th of May:
Second point, AMC now has an army of passionate, interested individual shareholders, some 3 million strong. The exact number was 3.2 million shareholders on March 11th, the last time we got an investor count. They owned more than four fifths of our then 450 million outstanding shares as of that March 11th date. Since then a lot of AMC shares have changed hands.
These individual investors likely hold a majority of our shares. They own AMC. We work for them. I work for them. So, by definition, their interests and passions are important to AMC. Their interests and passions are important to me.
Mr. Adam Aron is riding the wave while simultaneously issuing tons of new equity in the market.
And finally, you have the announcements like the one on Mudric Capital buying $230m stake in the company that was initially portrayed by media as a long-term investment in the company and likely added the fuel to retail investor excitement. And then of course this happened on the same day:
Is AMC really overvalued?
Although I do not think fundamentals are really relevant in this case. Here are some high-level numbers:
As you can see in the table the asset base has not really changed since pre-covid – the number of theaters and screens has remained virtually the same. The company has increased the share count 5x with continuous equity raises over the last half a year. Also, I am generously assuming AMC is able to reach $1bn in annual adjusted EBITDA sometime in the future (not this year, and probably not in 2022) by deploying its newly raised $2.5bn cash war chest for expansion – although the majority of it will most probably be spent for retiring debt and upgrading existing movie theaters. IMHO the movie theater industry is doomed in its current state – it was on the downward trend already, and covid just accelerated the switch to streaming – so the $1bn EBITDA assumption is likely to be overly generous.
Also it is quite hard to imagine a short squeeze with so many new shares getting dumped in the market by the company every day.
Parallels with GME trading
Elevated stock trading volume for AMC is already ongoing for way longer than it has for GME back in Jan’21. Obviously, the starting days at the bottom of the table are arbitrary and we might be at a different stage of AMC drama.
Risks
Selling options is inherently risky – the upside is capped at premium amount and the potential losses are unlimited. AMC stock remains very volatile and could easily double or triple from the current levels with no fundamental support whatsoever. The market is saying that these options should be priced at the current levels and the market is usually correct. This is not an investment advice and do your own research before investing.
And finally, always worth keeping in mind – “market can remain irrational longer than you can remain solvent” (Keynes).
This idea will no doubt earn you money 99-out-of-100 times (if not more). But that 1-out-of-100 times you will get wiped out. I’m sure these kinds of ideas add to the return of the tracking portfolio short term, but what makes you think you really have a long term edge here (which I’m guessing is a condition for an idea to get posted?)? I’m pretty sure earlier this year GME went much higher than most of us would have thought possible.
The “Risk”-section of this idea is very much on-point; considering this, why is this still a good idea?
I think there are several things that make this a good and timely idea:
– Company keeps issuing new shares through ATM program – the risk of short squeeze is drastically reduced with ever-increasing float;
– Options are way out of the money and expire in two weeks – I have not seen options trading at these levels, but GME’s might have been priced similarly;
– Market cap needs to be 20x+ above ‘normal’ levels to start losing money on this trade; (note GME also reached 20x+ above normal levels)
– AMC interest on WSB seems to be fading – whoever was pumping it, is cashing out now (assumption);
– Borrow costs are coming down not up (20% yesterday and 11% today);
You are correct in saying that I do not have a long-term edge here, but the pattern is very similar to what everyone saw at the end of January – the buying simply gets exhausted at some point even for the newly minted crowds on retail investors. And we are now at the end of the second week of this WSB trade.
The rational investor in me agrees with you. But there’s nothing rational about this situation. The stock tripling in the past week isn’t rational and neither is its current level. While the ATM program and borrow rate are fundamental indicators, there is a completely unknown meme tail risk from a celebrity tweet or something else. This trade is free money with a marginal sliver of getting your face torn off risk
GME’s were priced even higher iirc. But it all depends on the chart whether new highs were being made as the gamma squeeze is real.
As for market cap, if a meme coin can get near $100B in market cap lets not pretend this has a limit of $50B or $100B. This could get to $1T if worldwide attention fixed on it for a few days as people treat the stock like a digital coin to gamble with.
Borrow rates aren’t the problem, its margin rates. When I was short GME, the margin was 3x iirc at Interactive Brokers. So a 100K bet took on 300K of margin and then when it got to 200K now I had to put up 600K + the 100K I was down. A $100 stock, selling $200 CALLs, now at $350, then at $450 was taking up over a million at some point. This is why when robinhood shut off buying, it crashed that morning only to rip back to $450 where the liquidation of shorts forced us to cover on the same day only for it to crash to $100 a hour or two later.
When the social media crowd focuses on a stock, best to treat it like a digital coin. No one would say “Bitcoin HAS to stop at $100K or $200K” because its gone from $100 to $50K already so we know there is no upper end in a mania. Same with AMC or GME, there may be no upper end in the short term if it gets above $500. $1K, $5K, why not?
Someone I know who timed GME options perfectly looked purely at technicals and flows. I think the fundamentals really don’t matter. Perhaps it is possible by looking at the IV the MM are demanding? I’m not experienced enough with options, perhaps someone else can chime in.
My only concern is that lets say we have historically seen IV top out at 800% (which is what AMC hit at one point and which is a completely insane level); what is to stop the meme trade being bigger this time than last time. As there a mathematical limit / can you calculate back envelope the capital requirements beyond which a new peak seems unlikely?
“AMC shares trade above $153 (i.e. AMC market cap of $75bn!!!) – calls get exercised and call sellers lose the whole received premium and potentially multiples more.”
When GME went from $40 to $100, I sold the $215 CALLs for around $10 a week or so out thinking that was so dumb a $4 company that just recently spiked could do it again to get to $200. Well at $350 AH trading a few days later, I was down over $100K and lay in a shower at 2am in fetal position because my stomach hurt so much.
In 30 years of investing/trading, I’ve never seen this type of social phenomenon where mob investors storm a stock and care so little about their capital. Taking joy in the gains, laughing at the losses, buying OTM CALLs like people placing bets on a roulette wheel.
This AMC bet probably will work just fine but if there is a 0.5% chance to lose years of gains and a 0.1% to lose a lifetime’s worth, is it worth that premium?
I’m a conservative investor who rarely speculates with options, but I appreciate seeing this idea spelled out. I wouldn’t do it with a few million dollars, but I’m tempted to do it with a few thousand dollars. There is no chance of me being wiped out if I size this spec accordingly.
Famous last words
Better risk reward is selling the short-term puts in the teens
Why? I see equivalent risk/reward seems to be selling puts mid 30s. You’ve got to sell 20+ puts at the 15strike for every put sold mid 30’s (or call sold + 145). I understand why it is much less risk, I just don’t see the reward improvement apples to apples. (Keep in mind price is moving a lot so my numbers may be way off when the post comes up)
If the stock breaks, the IV will collapse so your puts won’t even increase in value. If the stock rallies, the IV spike will turn that $7 call into $50. Also, unlike oil, the stock can’t go negative, so you only risk what you can cash cover and since they just raised almost $1B, it’s unlikely the stock goes back to where the squeeze started. I say that is a much higher probability than the stock continuing to squeeze up. I am short a tad of the call wing, but it’s a much better trade to go after the puts with IV at these levels(at least yesterday).
“I say that is a much higher probability than the stock continuing to squeeze up. ”
You mean there is a much higher probability of AMC dropping below mid 30s than continuing to squeeze up, but a much smaller probability of going back to the teens, right?
If I understand correctly, you conclusion is that, in the order of attractiveness: short put at mid-teens strike > short call at $145 > short put at mid 30’s?
As parallels are clearly being drawn, I have added the table of GME vs AMC trading for easier comparison. The key takeaway for me is that AMC is trading at highly elevated levels already since mid-May – if these trading levels have not managed to push the shares higher, what will?
Also GME at the peak price reached market cap of $33bn with far more limited float. It is really hard to imagine AMC can now be pumped to $75bn when probably close to 90% of shares are already in retail investor hands. Who will be new buyers of AMC shares? With these daily trading volumes we need much more than the marginal buyer to triple the market cap here.
If I recall correctly GME had higher implied volatility on the longer dated options. I sold and still have some GME Jan22 puts strike $4.50 for over a $1 at the time. AMC implied volatility is weighted more heavily on the front month rather than further down the calendar (in comparison the GME on Feb. 1st). I don’t know who the new buyers of AMC shares will be, but I will speculate it could be the funds that are selling the calls and covering. The call buyers (I think) are retail.
“Overall options trading in the stock remains overwhelmingly driven by retail traders, the data shows. Only about 10% to 15% of overall daily AMC options volume this week was traded in blocks of over 100 contracts, a size typically associated with professional players.”
https://www.reuters.com/article/us-usa-stocks-meme-options-idUSKCN2DJ0E4
I also think the premiums for far out the money options are elevated as these are being used for hedging in bearish call spreads – that would explain why the premiums of the $100 strike and $145 strike do not differ by that much.
I think this is good trade. I’m already in it, but I only do it as play money. I do these with 1%-2% of my investable assets. If the stock spikes, my strategy is simply to roll the contract out to the next week or month and keep the same exercise price.
Eventually fundamentals will prevail and the stock will come back to earth. Just make sure that you have plenty of spare capital. Never ever do this on margin.
If we sell puts, we certainly can make sure that we are fully cash-secured and are not doing it on margin, as AMC price can go only as low as zero.
When we sell calls, as patrick explained above, there always is a possibility that our exposure can spin out of control, even if it starts as only 1-2% of our assets.
Thanks for the idea DT. Obviously risky but interesting idea nevertheless.
This idea is only worth putting serious time and money into if there are 10 such situations and you can get some diversification.
The puts are much better sells imo if you are mostly interested in capturing the option premium. IV rises/falls together with share price so the calls are an extremely leveraged directional bet, whereas puts can fall even if share price drops, as long as it doesn’t crash rapidly, and these meme stocks have a surprising ability to stay elevated for longer than most expect.
As expected, AMC Jun $145 Calls have expired worthless and the option sellers captured the whole premium. Closing this idea with 100% gain in 2 weeks.
Not claiming any large victory here – as some members have suggested in the comments above, these type of trades probably work out 99 times out of 100. Having said that, IMHO the stars were very well aligned here and premiums way exaggerated – if I could do these type of trades 100 times a year and then one or two of them failed, I believe it would still end up being a very profitable strategy if trades are sized correctly not to get wiped out on the two failed cases. Obviously, the problem is that these opportunities are quite rare and one does not get a hudred shots but rather only a few increasing the risk that one of those few ends up being a black swan.
Option premiums for other expirations remain elevated (although not as high as at the time of posting) and there are further opportunities to profit from AMC volatility. E.g. as Walter suggested above selling OTM Puts (especially the covered ones) with short term expirations is one of the ways to play this. I also think there are a few catalysts on the horizon to bring AMC down to more appropriate valuation levels – the board is seeking shareholder authorization to issue more equity and the whole retail crowd excitement might fade out when the country reopens fully and previous movie goers fail to return to theaters en masse.