Ask HN: Is the options pricing model broken for deep GME OTM puts?

1 points by goo 5 years ago | 8 comments

TLDR the value of puts with a strike price of less than $5/share has gone way up, despite the stock price moving in the opposite direction. Is this a case of a mispricing due to a model that doesn't take into account this level of volatility? (...and thus a great opportunity?)

I noticed that with the volatility spike of GME over the past few days, with it ripping upwards, the puts with a strike price of less than 5 dollars per share have also increased in value. My guess is that because the volatility is now so high, the model for pricing options now believes it much more likely that GME will end up with a very low (<$5) share price. For many of these put options, they are valued much higher than they were a month ago when GME traded much lower.

Here's the options chain for GME: pay attention to the puts with strike price of $1-$5. https://ca.finance.yahoo.com/quote/GME/options?date=1616112000&p=GME

And here's an example chart of a couple of the options in particular: notice their value increasing over the past few days even though the share price is now quite high:

https://ca.finance.yahoo.com/quote/GME230120P00002000?p=GME230120P00002000 https://ca.finance.yahoo.com/quote/GME210319P00005000/chart?p=GME210319P00005000

It seems like from a logical perspective, the fact that GME is now a household name and that the company can dilute their shares to raise capital means that although the shares might crash back down again, they are extremely unlikely to dip below $5 in the next year or two. The options are being priced as if GME is going bankrupt this year (...and it's definitely not).

Does anyone have a counterpoint to this? Why wouldn't anyone with capital to spare just be loading up on cash secured puts for an extremely low risk ~10-30% return?

LatteLazy 5 years ago |

My counterpoint (purely from devil's advocate point of view) would be:

GME are a retail store in a digital industry. Their PC game market was annihilated by Steam. Now Xbox and PS5 are going the same way, both limiting resales and cutting out physical retail.

GME are a retailer that was deep in debt before covid. Now they've had months of covid. All those rents still have to be paid or the stores closed. Ditto staff.

What makes you think the company will even exist in 6months?

Right now, they're WSBs pet project. But I don't see that lasting till the end of Feb. If it weren't for RobinHood shenanigans and all the media coverage, they'd likely already be selling. As soon as the reddit hive mind withdraws, there isn't much support even for a 1usd price level.

This is basically the analysis of the hedge funds who shorted it in the first place.

Of course, all this is my personal prejudice against physical retail. I'm just explaining the other side..

goo 5 years ago | |

Thanks for your input. A couple follow-up questions though.

Why would the price on the low valued puts go way up though? Is it now, after the squeeze, MORE likely that GME goes bankrupt? And even Hertz, which is _literally bankrupt_ is still selling for more than a dollar a share, so the stock price could remain untethered from realities for a long time.

And why can't they just do some share dilution to raise capital?

icedchai 5 years ago | | |

Volatility is driving all options up, puts or calls. I have a deep in the money put (not as deep as those, it's at $25) that is up over 100% since last week. Too bad I didn't buy a call, too. I figured it was going to come back down quickly. Maybe in March.

LatteLazy 5 years ago | | |

Issuing new shares would let them raise capital, but then they have to do something with that capital. I don’t think they have much of a future so unless they have a CEO can both run GameStop and build something new on the side, he wouldn’t be helping anyone. Assuming the market feels the same way, the share price would fall a lot before the issue. Or he’d be taking money from WSB and wasting it on some doomed revitalisation.

Innovating while running a mature business is one of the most difficult things for companies and few succeed. Even Google mostly buy innovation rather than trying to do internally.

Models all use the volatility to guesstimate outcomes. More volatility means more value in an option. Look at it this way: if a stock is at 10$ and the vol is +/-1$ A day, you only need 5 down days for a 5$ option to be in the money. If the same stock shoots to 50$ over 2days, the vol is now +/-20$ a day (because it shot up at that rate). So you only need 2.5 down days and that 5$ put is in the money.

That’s effectively how the model “sees” GME.

I’d tend to agree that it doesn’t make much sense for the price to have changed given these circumstances. I think that’s an artefact of the model. To be fair, the model relies on volatility being relatively constant AND it being bidirectional (prices go up or down randomly). You can’t really use a model like this to price options on an underlying like GME.

This is where the skill comes in: you don’t just need to obey the model, you need to look at the market, decide it won’t stay this volatile, adjust you vol figure down and trade based on the new model price it gives you and hope the market comes to you before you go bankrupt!

But that takes insight and you have to actively manage the risk that creates if you’re working at volume.

If you’re willing to take that risk and you think GME will quite down, you can short some puts. That would limit your downside to volume*strike price. But you have to accept your eating some risk.

Personally I’d say GME options are not meaningfully modelable right now and you can make good money in disfunctional markets. I keep some cash for this sort of speculation myself. But I only gamble what I can afford to lose and I don’t kid myself I’m Investing.

I’m cash poor right now (covid and no job) otherwise I’d be tempted to try this tbh.

To be clear, I’m not an expert and this isn’t financial advice. I just did software support for a convertible bond desk for a year so I learned enough to hurt myself!

icedchai 5 years ago |

The risk of it dropping to <$5 is much higher than you believe. Look how fast it went up. The stock was <$3 back in the end of March.

GME's value is 1% fundamentals, 99% hype/madness.

arthurcolle 5 years ago |

The collateral required to sell these low priced puts will probably adjust in the coming days/weeks/whenever.

goo 5 years ago | |

The collateral on cash secured puts is always just the amount of money need to buy the shares specified by the contract. (Hence: "cash secured")

buffaloo 5 years ago |

Compound put?