GameStop – I'm Having A Volkswagen DéJà Vu
Value, Deep Value, Growth At A Reasonable Price
Seeking Alpha Analyst Since 2015
I have been investing in stocks since 2007. I have no preference for sectors or countries - I'm as comfortable owning a part of a cement miner in Peru as holding shares in a wheat farming firm in Bulgaria. If it's a value stock - great. If the dividend or share buyback yield is high - even better.
- Disclosure: I am not a financial adviser. All articles are my opinion - they are not suggestions to buy or sell any securities. Perform your own due diligence and consult a financial professional before trading.
- There’s a short squeeze going on at GameStop, which reminds me a lot of what I saw over a decade ago at Volkswagen.
- These types of events don’t last for long, but opening a short position could be dangerous.
- There are several options strategies that could deliver good returns for investors, even if the company’s shares continue rising in the following days.
All of this has happened before, and it will all happen again - Sir James Matthew Barrie, used by multiple Battlestar Galactica characters
Short squeezes like the one happening right now with the shares of troubled video game retailer GameStop (GME) are not uncommon. In fact, the way it’s playing out is very similar to what I witnessed in 2008 with German auto giant Volkswagen (OTCPK:VLKAF), around a year after I set foot on the stock market.
I'm experienced now, professional. Jaw’s been broke, been knocked down a couple of times and I know how all of this will end up as well as what are some possible ways to make a profit off the inevitable fall of GameStop’s shares.
Similarities with Volkswagen’s short squeeze in 2008
According to a paper named "Short Squeeze" by Baixiao Liu and Wei Xu, during short squeeze a stock soars by an average of 20% in seven trading hours following the initial price increase. The following correction can last for months.
Of course, you need a spark for that initial increase. Back in 2008, Volkswagen was in financial trouble due to the global financial crisis and its shares were heavily shorted, The spark that started the short squeeze was an attempt by Porsche (OTCPK:POAHY) to acquire the company through the open market. Porsche’s former CEO and Wendelin Wiedeking and finance chief Holger Haerter later became the two highest-ranking German auto executives to go on trial.
There was this thing called the Volkswagen Act, which originally requited any party to own over 80% of the voting shares to gain control. However, the requirement was pushed to 75% and with the state of Lower Saxony owning 20.1%, this meant that Porsche had a clear path to takeover the company.
At the end of October, Porsche announced that it has accumulated a 74.1% stake in Volkswagen using cash-settled options, which meant that it was mathematically impossible for every short-seller to cover his or her position. Volkswagen’s share price rapidly soared to €1,005 and the automaker briefly became the most valuable listed company in the world with a market capitalization of €300 billion.
The shares jumped fivefold in a matter of days. Investors, fund managers and analysts were demanding for the suspension of Volkswagen shares from Germany's DAX index as well as an inquiry into manipulation and insider trading.
What you notice is that the high price levels didn’t last for long, just around a week. However, losses for fund manager were estimated to be as high as €30bn.
Let’s take a look at GameStop. The short version of the bear thesis is that the company has an outdated business model and that online sales are the way of the future.
Due to this, the company is heavily shorted and the short interest stands at around 140% of the float, according to data from financial data firm S3 Partners.
(Source: S3 Partners)
Short sales in the float calculation create the so-called synthetic longs, which become lendable as they settle in lending programs, marginable retail accounts and rehypothicatable hedge fund accounts. This is how you get over 100% of short interest as percentage of the float.
The spark for the GameStop short squeeze came on January 11, when the company announced the appointment of Chewy (CHWY) founder Ryan Cohen and two other e-commerce veterans to its board in a bid to boost digital sales. This was followed by herd retail investor buying due to social network Reddit and the involvement of Tesla (TSLA) CEO Elon Musk. GameStop’s shares have soared by over 1,600% as of Wednesday.
(Source: Seeking Alpha)
Older shorts started closing positions due to large mark-to-market losses but there is very strong demand for short positions, with new shorts paying a fee of over 80%.
Give me options
The problem with short selling is that investors face unlimited downside on their positions so put options make more sense in a volatile market. They allow investors to sell shares at a fixed price between now and a certain point in time.
As short squeezes rarely last long, I think it’s relatively safe to look at put options expiring at the end of February.
Another path you could take is to benefit from the price volatility. This can be done using an option strategy named straddle. This strategy includes the purchase of an equal number of call and put options at the same strike price and with the same expiration date, thus benefiting from significant moves in a stock's price.
For example, let's say there’s a stock trading at $100 and a $100 call option for February costs $3, while a put option at the same strike price and with the same expiration date is $2. In this scenario, you can get a $500 straddle: ($3 + $2) x 100 shares per option contract. The strategy will be profitable as long as the share price moves by more than $5 in either direction. This is the sum of the premiums paid for the call and put options.
A straddle includes involves at-the-money call and put options and these could be difficult to get at the moment so an alternative is a strangle. The latter is similar but it involves using out-of-the-money call and put options. Since the options are out of the money, this strategy costs less. However, it typically requires higher volatility to be profitable.
There’s a short squeeze going on at GameStop and if history is an indicator, it won’t last for much longer. These types of events aren’t that unusual and perhaps the most famous one is involves Volkswagen in 2008.
I think that opening a short position is dangerous but there are several options strategies that could deliver good returns for investors, even if the company’s shares continue rising in the following days.
Analyst's Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I am not a financial adviser. All articles are my opinion - they are not suggestions to buy or sell any securities. Perform your own due diligence and consult a financial professional before trading.
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