$GameStop(GME)$ is set to release its Q2 earnings report after the market closes on September 10, 2024. Analysts are predicting a loss of 9 cents per share and revenue of $895.67 million. Recently, GameStop announced it was terminating a $250 million credit line, signaling a shift in strategy to rely more on operational cash flow and reserves for funding.
To revitalize its retail business, GameStop is transforming some stores into retro game retailers. This move targets nostalgic gamers interested in classic consoles and games, tapping into the growing retro gaming market. The stock closed up 8.88% at $23.42 last Friday, and it continued to surge in after-hours trading on Tuesday.
GameStop Options Activity
On August 30, 2024, GameStop options trading was bustling, with a total of 371,500 contracts traded that day. Of these, 14.74% were puts and 85.26% were calls.
As of the close that day, the total number of Open Interest contracts (i.e., option contracts that have not been bought, sold or exercised) was approximately 915,800, representing 90.38% of the average of the past 30 trading days.
Notably, with GameStop’s price at $21.92, there was a large call option trade with 2,799 contracts worth $64,400. This call option has a strike price of $100.00 and expires on October 18, 2024.
Given the recent surge in call options, investors looking to bet on a potential big move in GameStop might consider using a ratio spread strategy.
What is a Ratio Spread?
A ratio spread is an options strategy where a trader buys one at-the-money (ATM) or out-of-the-money (OTM) call or put option, and then sells two or more of the same type of OTM options. This strategy can be applied to both call options (Call Ratio Spread) and put options (Put Ratio Spread).
If traders are slightly bearish, they use a put ratio spread. If they’re slightly bullish, they go with a call ratio spread. Typically, this involves buying one long option and selling two of the same type of OTM options, though the ratio can be adjusted. The maximum profit is the difference between the strike prices of the long and short options, plus any net credit received.
However, traditional ratio spreads have the downside of limited upside profit. That’s where the call ratio backspread comes in.
A call ratio backspread is an options strategy where you buy call options and sell call options with different strike prices but the same expiration date, using ratios like 1:2, 1:3, or 2:3. Because you hold more long call options than short ones, this strategy can offer unlimited upside potential.
In a call ratio backspread, you sell fewer calls at a lower strike price and buy more calls at a higher strike price. This approach aims to profit from a rising market while capping potential losses if the market falls.
Example of GameStop Call Ratio Backspread
The goal of a call ratio backspread strategy is to capture greater potential gains when the stock price rises. Here’s how it works:
Step 1: Buy Call Options: Invest in 3 call options with a strike price of $31, expiring on October 11, 2024. Each option costs $175, so the total cost is $385. These calls are aimed at profiting if the stock price goes above $31.
Step 2: Sell Call Options: To offset some of the cost, sell 1 call option with a strike price of $22.5, also expiring on October 11, 2024. Each option sells for $333, generating a total income of $333. Selling this call provides initial income but could lead to losses if the stock price rises.
In this case, you can see how the ratio spread changes the profit ceiling. By adjusting the quantities of bought and sold options, you can fine-tune your bullish or bearish stance.
The backspread strategy allows for big gains when the market moves as expected and limits losses if it doesn’t, making it a strong choice for a trending market. Compared to just buying strategies, it reduces time decay and still offers potential profit if the market doesn’t move as anticipated. It’s a strategy worth considering for your investment mix.
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