GAMESTOP: When Will The Game Stop
Eternal hope might be your last hope.
Executive Tease
When you go to a funfair, and your cash isn't mature.
Upbeat earnings could mean downbeat price.
We choose butterfly spirits at twenty bucks and see where we can fly.
PS: See ”4.1 MacroDozer Conviction” for a real summary.
Bed Bath Beyond, FTX, GameStop. First, Signature, Silicon... and NFT stands for No F*cks Taken. It's not my fault that "good cop, bad cop" isn't working for you, but I'm telling you, I wasn't stealing from the people! They must have mistaken me for some God since I never anticipated monetary offerings of this magnitude. Besides, Elon, Peter, Kevin; they’ve been doing this for decades now, and it seems to be working just fine for them!
1. Driving Forces
While all sorts of U.S. government institutions are busy trying to bring order to the endless chaos of meme mania and crypto craze, and a new generation of Federal Reserve chairs and bank managers are unable to properly set maturities for the world's simplest investment instruments (cash), we'd love to dive deeper into this funfair.
There is no shortage of elevated implied volatilities and inefficiencies, and we feel obliged to sell pricey premium to keep these markets liquid and perhaps make them just a little more efficient.
We prayed hard that Racket Ryan would give us another chance to finally get into his primary vehicle of abuse, Gamestop (GME), and bet against his last bloated horse in his shallow circus. We managed to do a little warm-up sparring in his former BBBY arena. He quickly abandoned the sinking ship as it shot out of the water one last time before finally sinking to the bottom of the ocean along with his now financially drowned retail mob.
Even though the relative implied volatility of GME, i.e. current implied vs historical implied, is not peaking, the absolute implied volatility is still at 100%. By comparison, the S&P 500 and NASDAQ are currently at 24% and 28%, respectively. Good enough for us to sell premium south of the current share price around the 50-day mean and bet on a further decline in volatility and a normalization of the share price after the earnings jump.
Rant Around Faith
Racket Ryan, Cohen the Barbarian, the Ruler of Retail, the Holy Boy who handed over his losing BBBY bag to his mesmerized disciples, is still part of GameStop. Blame him? Blame his followers?
Faith must somehow be lived out as an existential need of human existence. Religions with their outdated dogmatic rituals are increasingly rejected. So why not worship partners, favourite sports teams, digital tokens, or immature leaders who are noisy enough to be considered alpha and wise?
I emphasize the spiritual aspect of it because once you understand that you are dealing with religious movements and no rational investment environment, your trading strategies and results will improve. Do you want to ride or challenge a religion? Maybe. Just make sure you understand the rules and rituals before you get involved.
We believe in volatility, the almighty movements. The holy ghosts of memes, the losing bags of our fathers, lords, and the spirits of the markets.
Ryan. Chapter 1: Verse 1-3; SEC Form 3-4 + 8-K Current Report [2023-03-21].
2. Background Information
To briefly answer the question posed in the article's headline: The games aren't stopping anytime soon. Unless an activist investor jumps ship again, dragging most retail investors along and leaving a share price reflecting a market capitalization of maybe 0.30x sales with no ability to further fund annual losses by selling overpriced new shares.
GameStop is a rapidly shrinking, loss-making retail chain that sells new and used gaming the old-fashioned way. It's a wonder it still exists. Small investors have allowed GameStop to sell billions of dollars worth of new shares into several short-squeeze rallies and pay off its entire debt.
However, the company has not found a way to reinvent its business model, and we do not believe it will be able to do so. Cost cutting will only get you so far, but when revenues are shrinking, and annual cash burn is close to a billion, you must sit down and consider all the plans and alternatives when your playground is a dying industry.
Liquidation would most likely be the best solution, with all stakeholders receiving adequate compensation while there is still money and time to look for new and perhaps more contemporary projects.
2.1 Financials
A quick look at the Q4 non-GAAP numbers shows we had a legitimate positive earnings quarter, with no apparent creative GAAP/non-GAAP accounting stunt. GME reduced the cost of goods sold and admin expenses and, as a result, reported upbeat Q4 earnings of 16 cents per share.
However, nominal revenues continue to decline in a high-inflation environment, and the main reason for the lower cost of goods sold seems to be a one-off disposal of inventory. The entire fiscal year shows yet another significant loss for the company.
There is no debt and more than a billion dollars in cash on the balance sheet; maybe management can use that to get business pal Sam B.-Fried out of his parent's house and devise a novel idea.
Ah, wait, sorry, they already tried collaborating with Sam before he was arrested. So let’s burn it all over the next 12-18 months.
2.2 Valuation
The current EV/sales multiple stands at 1.0x. The industry standard for a loss-making computer and electronics retailer is 0.25x. GME could easily trade at $5.00 instead of $22.00, ignoring other risks.
3. Trade Execution
When setting up yet another meme trade, this is where the ζeta (alpha) seems to be for us these days, we need to ensure we are adequately hedged against price squeezes, implied volatility explosions, and assignment risks.
By their very nature, option chain call and put sides can respond differently to unusual events such as short squeezes. Therefore, we opt for a put-only setup this time (Butterfly), dampening the overall price swings and eliminating assignment risks of any in-the-money short calls.
As we enter the trade early, we start with 25% of the standard trade size, which can be increased to 100% in the next few trading days if feasible.
We are buying a slightly bearish Butterfly, two short 20 puts, one long 15 put and one long 25 put, with May 19, 2023 maturity.
Break-evens are at 23.50 and 16.50.
3.1 Trade Entry - Mar 24, 2023
GameStop has very liquid option chains. As a result, we were filled precisely in the middle between bid and ask.
Total: 1.45 Debit.
3.2 Trade Risks
Price: Short-squeeze risk: 40%. Merger or acquisition risk: 5%. Bankruptcy/ liquidation risk: 1%. Maximum loss at maturity: Defined.
Volatility: A potential short-squeeze would come with an implied volatility explosion. A put-only Butterfly setup will protect against that reasonably well, and the maximum loss at maturity is defined.
Assignment: The short puts can only be assigned if the share price falls sharply below the 20 strike. We would then exit the trade. Risk: Minimal.
4. Expected Value & Conviction
One of the secrets of successful trading is to master your maths. An important principle is the expected value (EV), which indicates the expected profit or loss if you make the same trade indefinitely.
Expected Value = (Probability of Profit * Expected Profit) - (Probablity of Loss * Expected Loss)
Broker Data with efficient markets should show an EV of 01. In comparison, MacroDozer Conviction gives us an EV of 78 and an equity EV of 53% on early trade close.
4.1 MacroDozer Conviction
The market assigns a probability of 0%2 for an average expected profit at maturity of 266; we believe that the probability of achieving half of the maximum profit of 355 (= 178) is 60% with proactive trade management and early trade closure.
The share price will likely revert to the mean after one-off positive quarterly results due to inventory disposal.
Market capitalization inflated by at least 400%.
Turnaround of the company is improbable, high cash burn, dying industry.
A further short squeeze is unlikely, as short interest is relatively low at 22% free float, and borrowing costs are only 15%.
Potential price pressure from activist investor Ryan Cohen, known for his quick exits.
5. Final Chapter
Expect updates on BrainDozers within 4-6 weeks. We use the exact heading, ending with (+/- xy%), and label the cover cartoon with a red CLOζED stamp. That way, the performance will be easy to follow.
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My name is Juri von Randow. You can find me on the top banner to the right. MacroDozing, as if there was no tomorrow. (Email version only.)
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All BrainDoζer articles are educational only; they are not tailored to any person or portfolio and do not constitute investment advice. Let us know if you are interested in implementing any of our ideas. We might be able to help or point you in the right direction.
Rough estimate. Precise calculations will be made for future BrainDozer articles.
Rough estimate. Precise calculations will be made for future BrainDozer articles.