GameStop (GME) Premiums Reflect Worries

One of Tuesday’s biggest decliners was video game store operator GameStop Corporation (GME) whose share price took a 20% tumble to $36.18. Such was the magnitude of its near $10-price fall that the exchange initiated a short sale restriction. The same occurrence followed Lululemon’s (LULU) shortfall on Monday. Of interest to options traders following the price dislocation is what equity derivative’s valuation is signaling over the coming two years. We look at share price outcomes through the lens of the IB Probability Lab. Option prices at a specific point in time show investors the Probability Distribution or likelihood of the underlying share price settling between certain strike prices. What’s unusual about today’s profile is the likelihood of a big downside move in two years’ time. This is clear when comparing the Probability Distribution for the January 2015 expiration with that of the January 2016 expiration.

Option valuation one year forward suggests a 52.14% likelihood that shares in GameStop will settle below $34.00 in January 2015. Specifically the strip of options suggests that its shares will settle at $35.63 compared to today’s $36.18. The odds of such a move occurring in 2016 are roughly the same. But in addition there is a one-in-four chance that shares in GameStop will close below $24.00 next January.

Chart – January 2015 GameStop Corp. Probability Distribution

(click to enlarge)

Turning the clock forward by one-year shows higher assigned probabilities of a bigger price drop. Typically we would expect to see a smooth bell-curve with lower likelihoods assigned to prices distant to the current underlying value. However, the IB Probability Lab shows that there is a 36.35% likelihood that shares will close below $25.00 by January 2016. While that makes perfect sense because of the additional amount of time that an adverse or positive event could drive the share price significantly away from the current trading price, such likelihood is raised at this precise moment in time on account of the relatively high cost of the January 2016 $25.00 strike put option – the lowest strike contract available to traders. Its premium of $3.90 per contract ensures increased odds of even lower outcomes, especially with implied volatility at an elevated reading of 43%. Having said that the reading is lower than it started out for 2014 when it hit 54%.

With short sale windows currently closed and the shares showing few signs of stabilization yet, it is likely that excess demand for put protection at lower strike prices is pushing up the displayed chances of a move down the road. And while this is not on display in the 2015 expiration the 2016 appears to be skewing the roadmap according to the IB Probability Lab.

Chart – January 2016 GameStop Corp. Probability Distribution

(click to enlarge)

About Andrew Wilkinson 1023 Articles

Affiliation: Interactive Brokers

Andrew Wilkinson is the senior market analyst at Interactive Brokers Group, where he provides daily commentary and analysis on U.S. equity options trading throughout the trading day. Andrew provides webinars designed to explain option-related trading scenarios covering futures, fixed income, forex and equities.

Interactive Brokers: Interactive Brokers offers direct market access to around 80 electronic global markets from a single account. Successful traders and investors understand that superior technology and lower trading costs can result in greater returns. For 32 years we have been building direct access trading technology that delivers real advantages to professionals worldwide. With consolidated equity capital of US $4.4 billion, IB and its affiliates exceed 1,000,000 trades per day. In addition, our prudent and conservative risk policies make Interactive Brokers a safe haven for your money. Discover some of the reasons why IB, the largest independent US broker/dealer, is the professional traders' and investors' choice.

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