Written by The Option Sensei (https://optionsensei.com/)

Earlier this week I highlighted how bears were making money shorting stocks.  But short selling can be a dangerous game, as you’re always at risk of a short squeeze inflicting large losses.

A short squeeze happens when a stock has a large portion of its float sold short.  Remember, every share sold short is like an embedded buyer, as those shares will eventually need to be bought to close the position.

If the stock price begins rising for one reason or another the people who are short maybe be forced to buy to cover or close their positions as they need to limit losses or get a margin call from their brokerage firm.  This in turn drives the price higher, forcing even more short covering and before you know it the squeeze is on.

I think Gamestop has multiple pieces in place for just such a squeeze to take place in coming weeks.

  • Fundamentals: People have been predicting the death of Gamestop for over a decade, basically assuming it will meet the same fate of Blockbuster or other physical/mall-based retailer whose product can more easily purchased online.
  • But a few things that have allowed the GME to defy the odds; it has retained a lock on the profitable, albeit shrinking, used game resale/trade in segment. It’s created a more interactive experience in the stores encouraging young gamers to come and hang out. It’s successfully growing its digital/online sales and lastly, it has a rock solid balance that allows it to pay a dividend of $1.52 per share, which currently equals a 10% yield.
  • Technical/Chart: In September, the stock quickly recovered from a sharp sell-off and in the process broken a long-term downtrend. It has now consolidated into a bullish wedge at the $14.50 support level.  It looks ready to move higher.

As mentioned above, there is an extensive history of people who believe the company is going to be ‘Amazoned’ out of existence. This has created large short interest with over 32% of the float sold short. This creates the possibility for a squeeze.  

To profit from a potential for a short squeeze I want to buy calls outright. This will give us the full leverage and ability to exit for maximum profit at any point prior to expiration:

I’m buying the October (10/19) 14.5 calls for around $0.50 each.

I have a price target of $16.5, which would give the calls a minimum value of $2 for a 150% gain.

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