AMC stock (AMC) - Get AMC Entertainment Holdings, Inc. Class A Report investors, many of whom identified with the “ape community”, commonly use options trading to express their bullish views on the stock. The strategy makes sense on the surface, given (1) the leverage effect, (2) the limited downside risk and (3) online brokers’ low commissions.
However, trading options can be very costly and cause the bullish play to backfire. Wall Street Memes discusses the implications of trading AMC options vs. buying the stock outright.
Figure 1: AMC's theater in New York City, NY.
Wall Street Memes | Daniel Martins
(Read more from Wall Street Memes: Who Owns The Most AMC Stock?)
Options: some background first
Options are derivative contracts in which the contracting party (the long side of the trade) is given the right to buy or sell a fixed amount of an underlying asset at a fixed price before the contract expires. A call option gives the holder the right to buy an asset; a put option, the right to sell it.
Buying call options helps a bullish trader in two ways. First, the maximum amount of loss incurred can only be the price paid on the option itself – even if the underlying asset, in this case AMC stock, were to go to zero. Second, options (especially out-of-the-money ones) can expose the trader to more than 100% of the notional value of the underlying asset, creating leverage.
AMC options: the pitfall
Think about it: AMC stock is very volatile, and the chances of its price going to the moon or heading towards something close to zero are not immaterial. Call options give the buyer unlimited exposure to the upside, but limited exposure to the downside. Why, then, wouldn’t all traders want to express their bullish views through options?
The simple answer: they cost too much. An at-the-money call on AMC that expires in only one week was worth about $7 per share on August 24. This is the equivalent of 15% of the value of the underlying asset. That is: the option holder could only begin to make money if AMC jumped another 15% in a matter of a few days.
Traders that buy these kinds of options regularly enough end up spending so much on the derivative instruments that they might as well have bought the stock itself.
Sellers are better off
At a higher level, option sellers tend to come out ahead of option buyers. This is not only an adage in the financial industry, but also a conclusion reached in academic studies. Therefore, in the aggregate, apes that use options to express their bullish views are likely handing money over to market makers who sell them the instruments.
The economics becomes even worse for apes once AMC stock rallies, as it did a few days ago. This is the case because implied volatility spikes when shares do so as well – likely driven by FOMO and greed pushing the option prices substantially higher. Notice below how volatility implied in the price of options shot to the moon in January and June, when AMC stock rallied viciously.
Figure 2: Implied volatility (calls) (30-day).
Wall Street Memes’ take
While trading options on AMC has its pros, it is likely costing apes too much, while slowly making option sellers richer. Before buying an AMC call, consider whether outright ownership of AMC stock might make more sense instead.
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(Disclaimers: this is not investment advice. The author may be long one or more stocks mentioned in this report. Also, the article may contain affiliate links. These partnerships do not influence editorial content. Thanks for supporting Wall Street Memes)