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GameStop (GS) reported surprise profits and positive free cash flow for Q4 and 2022 on March 21, including the first profits it has had in 2 years. This has pushed up GME stock over 40% and it is still at these levels, closing at $22.40 on April 7. This has led to very high option premiums that are popular with income investors.
I discussed the company's earnings and positive free cash flow (FCF) results in my Barchart article on March 26, “GameStop's Surprise Profits And Huge FCF Causes Unusual Options Activity.” For example, the Q4 net income was $48.2 million, compared to a net loss of $147.5 million for the prior year’s fourth quarter. In addition, I pointed out that its Q4 FCF was $326.6 million. That actually led to an increase in its cash balance, rising by 33% or $349 million during the last quarter.
Needless to say, if this keeps up the stock is going to continue to do well, especially if the cash burn stops as it did during Q4. This means that the stock is likely to stay fairly level, at least until the next earnings are released in early June.
In the last GME stock article, the short put premium trades for expiration on March 24 through to March 31 all expired worthless. That means that the trades were successful and the short-put investors kept all of the 2%+ income made in just 9 days. Moreover, going forward it makes sense to keep shorting OTM puts for income, given the high option premiums.
Shorting GME Stock Put Options for Income
For example, for the expiration period ending May 5, 28 days from today, the $20 strike price puts trade for 53 cents. That represents an immediate yield of 2.65% (i.e., $0.53/$20 put strike price).
This means that an investor who secures $2,000 with their brokerage firm can then enter an order to “Sell to Open” 1 put contract at $20.00 for May 5 expiration. The account will then immediately receive $53, giving it a 2.65% yield. As long as GME stock does not fall to $20 or below on or before May 5, 2023, the investor's return is secure.
But even if it does, the investor has a low breakeven price of $19.47 (i.e., $20-$0.53). This is 13% below today's price of $22.40 (i.e., April 6), giving the investor a good margin of safety. If that happens, the investor's $2,000 is exercised to purchase 100 shares of GME stock at $20.00. This could lead to an unrealized capital loss. However, this trade is very popular as there are now 239 contracts outstanding at this strike price.
Moreover, more conservative investors are shorting $18.00 strike price puts. They are trading at $0.20, providing an immediate 1.11% yield. Now the investor has less to worry about since the breakeven level is $17.80, or 20.5% below today's price. In other words, there would have to be some really bad news for the stock in the next 28 days for that to happen. Given the company's high levels of FCF and surprise profits, this is not very likely.
In fact, some investors may be playing both sides. They can short the puts at $20.00 and use that premium of 53 cents to purchase long puts for 20 cents. That gives some additional protection in case the stock falls significantly below $18.00. Here the investor still makes an immediate yield of 33 cents, or 1.65% compared to the $20.00 strike price. Granted, if the stock falls between $18.00 and $20.00 there is still an unrealized loss, but at least if something catastrophic happens, the investor's downside is limited to $2.00 less 33 cents, or $1.67 per put contract.
This shows that investors are taking advantage of the high premiums in GME put options to create good income opportunities going forward.
On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
