Wall Street Has a New Tactic in its Fight Against AMC: Options

Hedge funds were burned big time trying to short shares of AMC Entertainment Holdings, Inc., with losses of approximately $4 billion after the stock did this:

But like moths to the flame, they can’t seem to shake the temptation to bet against AMC and the Reddit retail hordes. Reuters reports that a new strategy is gaining popularity on Wall Street. It involves a complicated options trade called the “bear put spread”:

In the trading strategy, the investor buys one set of put contracts, which gives them the right to sell the underlying shares at a certain “strike” price by a certain time, and sells another set with a lower strike price valid for the same time frame.

The sale of the put options offsets most of the upfront cost of buying the first set of contracts. If the shares don’t fall, or fall less than anticipated, the trader’s losses from the put purchase will be covered to a large extent by the proceeds of the sold put.

This strikes me as a lot safer than short selling, but with a stock as unpredictable as AMC, I think a better move would be to avoid betting against it at all. Other overvalued stocks, of which there are no shortage these days, may be a better bet.

Not to be outdone, retail traders are piling into bullish options on AMC. These derivatives can magnify their gains beyond what simply owning the stock can provide:

Traders last week spent $11.6 billion on options contracts tied to AMC, more than on the SPDR S&P 500 ETF Trust, Invesco QQQ Trust and Tesla Inc. combined, according to Cboe Global Markets data. Options on those stocks are typically among the market’s most popular.

Bloomberg reports this demand is coming primarily from retail traders:

Trades involving 10 contracts or fewer are rising as a percentage of overall equity-call volume, according to data from the Options Clearing Corp.

This retail option buying can help drive the stock higher as option sellers need to buy shares to cover their exposure. After all, if the stock goes up substantially, they’ll have to pay out those gains to the option holders.

Because one option contract covers 100 shares, it’s easier to lose money faster in options than owning the underlying stock. Traders, both retail and institutional, would do well to be cautious.

More on meme stocks:

Photo: “Police Stationed outside AMC Theater showing Joker film 4573” by Brechtbug is licensed under CC BY-NC-ND 2.0

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