GameStonk breaks $100 a share (again)

Spring, is that you?

Is it just us, or did this week fly by quickly? In a pandemic world, that is no easy feat.

This week’s newsletter will focus on options trading. We admit, this is a confusing subject and it’s definitely not ideal for first-time investors.

If you’re an options enthusiast and are looking for fresh ideas, we actually have a Twitter account dedicated to options trading ideas generated by our AI.

Five headlines that sum up the week

1. Tech stocks did not thrive.

The biggest tech names in the book took a beating on Thursday, bringing down the indices with them. The S&P 500 fell 2.5% yesterday – the Nasdaq saw a decline of 3.5%. While it was the worse single-day performance for the S&P since January, the tech-dominant Nasdaq hasn’t experienced a tumble this bad since October. 

2. Boeing’s engine literally caught on fire during a flight over Denver

Boeing has grounded its 777-200 airplanes worldwide after an engine caught on fireshortly after takeoff. The same model had to make an emergency landing earlier today in Moscow after the pilot noticed issues with the engine control sensor. This is a tale of many sides; Boeing asserts that Pratt&Whitney, the aerospace company that makes the engines for the planes, and the FAA don’t have a formal process in place for inspections, which has led to them pulling all 777-2000 planes. Pratt&Whitney disagrees. In the case with Moscow, however, the plane was a 777-300ER, a 15-year old model equipped with engines manufactured by General Electric. We’re no experts here, but it sounds like all parties involved should be doing their due diligence here, not just the guys who are building the engines. 

Imagine trying to snap a quick pic from your window seat and you see this. #viral

3. Facebook reinstates news in Australia

After last week’s row with the Australian government, the social media giant has restored all news content on its platform in Australia. It agreed to do so after the country made a modification to the law, which now “must take into account whether a digital platform has made a significant contribution to the sustainability of the Australian news industry through reaching commercial agreements with news media businesses.” In other words, Facebook can be picky about which media publishers they support. The company has already signed a contract with Seven West Media, a major Australian news organization.

4. GameStop is a gift that just keep giving.

After a highly controversial – albeit entertaining – short squeeze and a congressional hearing with the likes of Roaring Kitty, GameStop stock is trading over $100 per share again. At this rate, it will end the week with its 2nd best performance ever. What is WallStreetBets saying? According to one user’s post, the rally on January 28 was not a short squeeze – it was a gamma squeeze – and what’s to come next is the “mother of all short squeezes.” 

5. 10-year Treasury yields hit 1.61% on Monday and investors are on edge

Why is this important? Analysts estimated that 10-year Treasury yields would hit that level by the end of 2021 – not before the end of Q1. When Treasury yields rise, all eyes turn to the elephant in the room: inflation. Historically, rising Treasury yields and inflation have always been associated, even if untrue. And to counter inflation, the Federal Reserve may have to raise interest rates. That has sent Wall Street into a frenzy, sparking the massive sell-off that adversely affected the tech sector this week. Other investors, however, suggest that the rising Treasury yields is due to the economic recovery we’ve all been waiting for. With the vaccine roll-out and stimulus, maybe there isn’t so much to be worked up about after all. 

This has been the week of positive vaccine news

The Johnson & Johnson vaccine could get approved by the F.D.A. as early as this week. The biggest upside to what would become the third available vaccine in the U.S. is that it can be stored in cooler temperatures and only requires a single dose. Some downsides include a much lower efficacy if you’re over 60 and have an underlying health condition. There’s also a debate about whether it’s safe for children under 16.

Multiple studies have found that even a single dose of the Pfizer vaccine can protect you from infection. This could be beneficial to vaccine rollout plans, especially for those who were already infected with the virus. Lastly, Novavax shared that its U.K. trials have demonstrated that the vaccine is 89.3% effective and expects to have its third round results by April. It has also found the vaccine to be nearly as effective against the highly contagious variant that was discovered in the U.K. last November.

How to explain options trading without confusing yourself

TL;DR

Options contracts give buyers the right, but not the obligation, to buy or sell securities at a set price on or before a set date. Investors use these derivatives to:

  • Diversify their portfolio
  • Support their investment income
  • Speculate on securities
  • Hedge against risk

While these investments carry some enticing benefits, such as the ability to hedge against losses, they also come with significant risks. Investors who seek profits from options contracts must be able to time the market just right – or get very lucky.

An Introduction to Options Trading

Like all investments, options trading can be intimidating. What are stock options? What do I get an option to do? How can having an option – whatever that is – make me rich?

Options trading literally sounds like another language.

What are Options?

Options are another asset class, just like stocks, ETFs and commodities. One way to think about options is as a bet between traders about how a security or asset class will move in the future. These securities are also known as “derivatives” because they derive their value from the underlying asset.

Options investments comes in the form of options contracts. 

  • call option gives the buyer the right, but not the obligation, to buy a security at a set price on or before a set dat
  • put option gives the buyer the right to sell a security

Typically, stock options represent 100 shares of the underlying stock. However, options contracts can be written on any asset class, including currencies and commodities.

Unlike other “advanced” investments, you can purchase options through a traditional brokerage account. However, most brokers will remind you that options carry a significant risk of financial loss, as they are speculative in nature.

FYI: Options were originally invented for hedging risks and losses against volatile market moves. Investors also use this asset class to draw income, speculate on potential price movements and diversify their portfolios.

What’s been going on with GameStop has largely been related to options trading

How Do Options Work?

There are four critical components to every options contract:

  1. The contract is the position of the contract (either a put or a call)
  2. The asset is the underlying security driving profits and losses
  3. The expiration date is when the contract expires
  4. The strike price is the cost of trading the underlying asset on the expiration date

Additionally, there are two parties to every options contract. 

  • The buyer (aka holder): can choose to either call or put the security of interest. But they are not required to exercise the contract ever, which limits their investment risk.
  • The seller (aka writer): obligated to exercise the contract if the option expires in-the-money. Sellers are exposed to potentially unlimited risk. Thus, they can lose much more than the initial premium.

Typically, buyers take their profits by trading out (closing) their position. In this scenario, a buyer sells their position, while the seller buys It back.

Options and Expiration Dates

Traders can accept one of two types of options contracts:

  • Short-term contracts: expire in one year or less
  • Long-term contracts: have expiration dates of one year or more

When the expiration date rolls around, if the contract has not been exercised already, there are two ways to resolve the option:

  1. Physical settlement: involves buying or selling the underlying asset at the set price. This is more common with stocks and ETFs. 
  2. Cash settlement: involves handing over the value of the assets rather than the securities themselves

Buying and Selling Options

Buyers and sellers can make one of four moves on their options: buying calls, selling calls, buying puts, and selling puts.

  • Just as buying into stock is taking the long position, buying a call option gives you the potential long position in the underlying security
  • Short-selling a stock gives you the short position, selling a naked (or uncovered) call gives you the potential short position in the underlying security

The opposite is true for put options. 

  • When you buy into a put, you are taking a potential short position in the underlying security
  • Selling a naked (or unmarried) put gives you the potential long position in the underlying security

Example of a Call Option

Let’s say that you want to buy a new car in the future and the dealership allows you to buy the car for $20,000, regardless of fluctuations in price, in the next 12 months. To hold the price of the vehicle, you put down a $2,000 deposit. 

In terms of options, this $2,000 represents your premium, or the price of purchasing the contract.

A few months later, you exercise your right to buy the car for $20,000. And, although the price of the vehicle actually increased to $30,000 in market value, the dealer has to let the car go for the agreed-upon price.

You have two options: you can buy the vehicle at full price when the contract expires or you can pass. Either way, the original dealer gets to keep your $2,000 premium.

Example of a Put Option

Let’s pretend it’s February of 2020, and whispers of a strange, fast-spreading virus hit your news inbox. This makes you nervous for your $10,000 in Microsoft, and you decide to minimize potential losses to 10%.

You take out a put option that allows you to sell your position for $9,000 at any point in the next six months. When March 2020 rolls around and the stock market tanks, you could exercise your right to sell your stocks for $9,000.

Regardless of whether or not you exercise your options, you’ll still have to pay your premium. If you do sell, you can immediately reinvest your money right back into the market to increase the number of stocks you own (at a steep discount).

Valuing Options

Valuing an option is all about determining the probability of a future price event. 

  • The more likely the event is to occur, the more expensive the profiting option position is
  • A longer expiration date leads to a more expensive option, as there is more time for the price to move in your favor
  • Volatility also increases the price of your option because the uncertainty means the stock has a higher chance of moving in your favor

  FYI: As the volatility of the underlying asset increases, the more likely a swing will move the security substantially closer to your speculated goal. Therefore, greater market volatility leads to more expensive options contracts. In this way, options trading and volatility are inherently linked.

Advantages and Risks of Options

Like all securities, options contracts come with their own advantages and risks.

Advantages

  • Requires smaller initial investment than purchasing securities outright
  • Limits exposure to risk on current stock positions
  • Protects investors by locking in prices at no obligation
  • Provides the investor time to watch the market move

Risks

  • Traders must be approved through a broker, and trades are limited to your assigned trading level
  • It’s difficult to accurately predict even short-term price movements
  • Investors may take on unlimited losses
  • Margin requirements can lead to higher trading costs

TFW you are on the receiving end of unlimited losses

The bottom line

Options trading is speculative in nature. Yes, you can make a lot of money. Additionally, it’s true that you can also hedge against risk. But you can also expose yourself to losses so big it might discourage you from investing ever again. Whatever it is that you do, heed with caution. And remember, if options isn’t your thing, there are so many other ways you can invest.

If you still aren’t clear about what happened with GameStop (it’s OK, we forgive you), this Washington Post TikTok does a fantastic job at explaining the events of January 28th – all in under a minute.a