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Trading Options On GameStop? GME Stock Price Action Explained

Posted June 4, 2024 at 10:00 am
Prosper Trading Academy
GME

The world of meme stocks is back with a vengeance, and GameStop (NYSE: GME) is once again at the forefront of this resurgence. Recent activity in GME has captured the attention of options traders, evoking memories of the storied 2021 frenzy. This piece delves into the history of meme stocks, the current data on GME and AMC, and the implications of soaring implied volatility for options trading.

If you need a refresher on Implied Volatility and how it can impact options pricing, you can download my free Implied Volatility Cheatsheet.

THE 2021 MEME STOCK CRAZE: A QUICK RECAP

In early 2021, the stock market witnessed an unprecedented phenomenon, driven by retail traders and social media platforms like Reddit’s WallStreetBets. Stocks like GameStop (GME), AMC Entertainment (AMC), BlackBerry, and Bed Bath & Beyond saw their prices skyrocket. This surge wasn’t driven by traditional fundamentals or valuations – but by social media buzz and collective momentum.

THE CURRENT MARKET SCENARIO: GME AND AMC IN THE SPOTLIGHT

Fast forward to today – and meme stocks are making headlines once again. GameStop has become a focal point for retail traders, closing at around $49 after a highly volatile trading session. Similarly, AMC Entertainment has also seen significant activity. The renewed interest in these meme stocks is reflected in the options market, where implied volatility has reached extraordinary levels, pushing up the prices of options contracts.

IMPLIED VOLATILITY AND ITS IMPACT ON OPTIONS TRADING

Implied volatility (IV) is a critical metric in options trading, representing the market’s expectations of future volatility. High IV typically leads to higher option premiums. For GameStop, the implied volatility recently soared from about 168% to 350%. This spike highlights a significant increase in demand for GME options, driven by speculation and the fear of missing out (FOMO).

To illustrate, let’s check out the at-the-money options expiring next week:

With GME trading at $49, the combined price of the 49 strike call and put options is around $33. This pricing indicates that the market expects GME to move by $33 – either up or down – within a week. Such a range ($15 to $81) on a $49 stock is a clear sign of extreme market volatility. If you need a refresher on the fundamentals of Implied Volatility and how extreme levels (like what we’ve seen in GME) can have a major impact on options trading, check out my free Implied Volatility Cheatsheet.

THE ROLE OF VEGA IN OPTIONS PRICING

Vega measures the sensitivity of an option’s price to changes in implied volatility. For GME’s at-the-money options, the Vega is approximately 0.03. This means that for every percentage point change in IV, the option’s price will change by three cents. Given the current IV of 525%, a reduction to 280% would significantly decrease the option’s premium by about $7.50, demonstrating the substantial impact of volatility on options pricing.

IMPLICATIONS FOR OPTIONS TRADERS

The elevated implied volatility in GME and AMC options presents both opportunities and risks. Traders need to be acutely aware of the premium levels, and potential for volatility contraction. A return to more normalized volatility levels could lead to substantial losses for those currently holding expensive options contracts.

CONCLUSION

The resurgence of GameStop (GME) and AMC as meme stocks highlights the ongoing influence that retail traders and social media have on the stock market. While you can truly feel the excitement building both on social media and in the market, it’s crucial for traders to remain vigilant of the data behind the trends, and understand the mechanics of implied volatility and options pricing. 

As we navigate these turbulent times, staying informed about GME, AMC, and the broader meme stock movement is essential for making strategic trading decisions. I don’t know if I’ll be trading GME or AMC at these levels, but if you want what stocks are on my radar you can sign up for my free weekly watchlist.

Originally Posted May 28, 2024 – Trading Options On GameStop? GME Stock Price Action Explained

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