Options Update: GameStop Corp. Scores a Flood of Call Activity

GameStop Corp.
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said that it will team up with Capcom Entertainment Inc. and the EVO Championship Series to host Street Fighter IV video game tournaments at more than 2,400 of its U.S. locations beginning on Saturday, Feb. 21, 2009, according to a company press release today. The tournament is one of several events GameStop will host surrounding the launch of Capcom’s Street Fighter IV.

While this news was a highlight of my morning – I wasted a small fortune in quarters playing coin-op Street Fighter II in my younger days – I doubt today’s options traders are piling into call options out of excitement over the revival of a late 1980s fighting game (one can always hope, though). Taking a closer look at GME’s options activity reveals that more than 20,000 of these bullishly oriented options have traded so far today. What’s more, call volume has outpaced the stock’s daily average by nearly 9 to 1, placing the shares on our Intraday Volume Explosion List.

A majority of this volume, about 4,900 contracts, was concentrated at GME’s February 30 call, which sports open interest of just 3,250 contracts. As you can see from the chart below, much of the February 30 activity changed hands at the ask price, suggesting that these contracts may have been bought to open.

GameStop option volume details

The Anatomy of a GameStop Call Position

Scanning today’s GME call data, I noticed that 3 blocks of 100 contracts changed hands at the ask price at 10:16 a.m. Eastern time on the same exchange – suggesting that they were part of a larger position. Assuming these blocks are related, the total outlay for this position would be $12,000 — (0.40 * 100)*300 = $12,000. For this trade to reach breakeven, GME would need to rally about 19% to $30.40 per share from yesterday’s close of $25.62 per share before the options expire on Feb. 20. The maximum loss on this position is limited to the initial investment of $12,000.

By entering this trade, the investor is indicating that he expects GME to rally sharply during the next couple of weeks. The shares have jumped more than 3.5% so far this afternoon – a drop in the bucket compared to the 19% gain needed for the aforementioned trade to reach breakeven at expiration. That said, let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

From a technical perspective, GME has gained more than 18% so far in 2009, far exceeding the S&P 500 Index’s (SPX) loss of more than 7% for the same time frame. What’s more, the shares enjoy the support of their 10-day and 20-day moving averages – short-term trendlines that have help push GME steadily higher since early December 2008. The stock recently bested potential resistance in the 25 region, but has stalled once again at the 27 level. This region has largely held GME in check since early November 2008, and could pose a significant hurdle for a February 30 call position.

Daily chart of GameStop since November 2008 with 10-day and 20-day moving averages

The Sentiment Drivers

Sentiment toward GME is largely bearish. Despite today’s preference for calls, options traders have loaded up on puts recently. Specifically, the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 1.06 ranks above 92% of all those taken in the past year. Furthermore, the International Securities Exchange and Chicago Board Options Exchange’s 10-day put/call volume ratio of 2.02 indicates that puts bought to open have more than doubled calls purchased during the past 2 weeks. Underscoring this pessimism is the fact that the ratio ranks above 96% of all those taken in the prior 52 weeks.

Short sellers are also betting against GME. Currently, the stock’s short-to-float ratio stands at a respectable 4.36%. The number of GME shares sold short slipped by 1% during the most recent reporting period, and if this trend gains any momentum, it could lend buying strength to the equity.

However, Wall Street analysts are excessively bullish toward the equity. According to Zacks, all 13 brokerage firms following GME rate the shares a “buy” or better. This configuration leaves the door wide open for potential downgrades, and provides another strike against an out-of-the-money call position on the security.

Sentiment indicators for GameStop

The Verdict?

A call position on GME looks quite attractive at the moment, given the heavy pessimism among options traders and the potential for unwinding short interest. The stock’s budding technical uptrend also factors favorably into my expectations for the security. However, a February 30 call seems a tad too aggressive for my tastes. Personally, I would look more toward a March 25 call – currently trading with an ask price of $3.70 — which would need GME to rally only 8% from its current trading range, while providing an additional time premium for a cushion against market headwinds.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.