Taking advantage of volatility spikes in meme stocks

I'm largely of the opinion that meme stocks are poor investments and it's best to stay away from selling options on them. However their occasional intraday volatility provides some very nice vega-centric opportunities on the option chain. A couple good examples of this lately have come with AMC and GME.

I have a video detailing how this works here. It should help explain things a little more visually but for more detail I'm writing it all out below:

For a little background, this approach looks to capitalize in a large intraday or overnight spike in a stock. The opportunity allows for us to sell puts out of the money and profit as the stock settles. The great part is that we don't have to get in early and guess which way the stock will run, but rather we wait for the volatility and use that opportunity to react to it.

More specifically, we look for 4 main points on these trades.

1) A spike in the stock. This one is pretty self explanatory. Whether it's overnight or intraday, we're just looking for a large green candle

2) Good news driving the spike. This can be anything from positive earnings to potential acquisition rumors. The key point here is that we want to avoid is the "$X is moving higher today on no apparent news" trend we see a lot with highly shorted stocks. There MUST be an identifiable, logical reason for the green candle.

3) There must be an established trading base where the stock took off from. This concept will be a little clearer with the AMC/GME examples below, but if a stock sees a big green candle and jumps from 15 to 20, we want there to be some sort of established trading history at or around $15/share as opposed to the stock jumping from 10 to 15 and then from 15 to 20. The reason we want to identify this level is because in theory even if the good news from #2 turns out to be a baseless rumor, then the stock should simply return to where it was trading before that news.

4) There must be decent option premium at the trading base we identify as a part of #3. For me this is typically anywhere 1% RoR or greater.

At this point it's important to take a step back and understand why this works and why this opportunity exists on spikes. You aren't going to find an opportunity like this just because a stock sees a large jump in price. A spike alone doesn't always create this type of opportunity, however a spike in price COMBINED with a spike in implied volatility does some pretty interesting things to the option chain.

Using the AMC example below (spoiler) we see an interesting trend with the price of the 4.5p we sold as the price of AMC increased. Not included in the video, here is a chart depicting the price of the 4.5p (candles) compared to the theoretical price of the option (purple. With the price of AMC jumping upwards, you would expect the price of the 4.5p to decrease, as depicted by the purple line. However thanks to the spike in implied volatility, the decrease in the price of the 4.5p lags a little bit. THIS is the idea behind what we're targeting here.

So let's jump into the examples:

Example 1: AMC 3/28 trade

On March 28th, AMC spiked from 4.71 to 5.50/share on rumors of AMZN exploring a potential takeover. The stock had been trading at the 4.40-4.60 level for the past week so we were able to identify that level as the "trading base".

So in just that short paragraph, we have 3 of the 4 elements we're looking for in a trade. We had (1) a large spike, (2) caused by positive news relating to a potential AMZN takeover on a stock that (3) had been trading within a 4.40-4.60 range over the past week. Now the only thing left to identify was option premium at that base.

The 4.5p expiring 3/31 fell squarely in the middle of that range so it would logically be our target for this one. At the time of this spike, which was roughly 1:30pm, we could sell the 4.5p for $0.12 of premium. That represents a $0.12 return on $4.38 of risk (4.5 strike minus premium received) which is a 2.7% return on risk. Comfortably in excess of our 1% target.

AMC uneventfully finished the week at $5.01, dipping down to $4.83 at its lowest. As such, our 4.5p we sold at the trading base were never in any real trouble and we made a very stress-free $120 since we sold 10 contracts.

Example 2: GME 3/22 trade

On the morning of March 22nd, GME was set to open as high as +50% after it reported positive earnings results. Right off the bat that meets criteria 1 and criteria 2 being a large spike based on positive news.

While it had closed at 17.65 before earnings, it had gotten up above $18 during that trading session so I was comfortable with considering the low $18's as our "trading base" for this opportunity.

That takes us to step 4. Would there be any premium on put options around 18? We know that our AMC opportunity existed due to a spike in implied volatility, but with this GME jump being driven by earnings I was a little skeptical of this opportunity since I felt IV crush would kill the deep OTM options. However, to my surprise the implied volatility actually briefly moved higher that morning thanks to the sheer magnitude of the spike. We were able to sell 10 3/24 18.5p for $0.15 shortly after the market opened.

While GME did move lower from its 26.80 open, it leveled out as it finished that day at 23.86. This was enough to kill IV (which consequently resulted in the deep OTM puts getting crushed) enough for us to exit this trade the same day we entered for a debit of $0.04. The $0.11 gain resulted in a profit of $110 for us in a few short hours.

One important thing to note on this one was the quick in and out. When IV dips back down and you can take a substantial amount of profit, do it. Anything can happen with these stocks and the shorter you're in the trade, the less time there is for something to go wrong.

I've run this strategy across several different stocks with a very high success rate. It works a lot, but of course things can always move against you so at the end of the day the best advice is to make sure you size your positions appropriately and feel comfortable potentially taking assignment at the strikes you sell. For me that means sizing it the same way I would size any other trade because at the end of the day the worst thing that happens is you end up with shares at a lower basis than where you first entered.