Buying into the meme stocks craze
What is going on with meme stocks once again? While there might not be any particular “concrete” reasons fuelling their recent price increase, we can perhaps speculate some theories as to why stocks such as Bed Bath and Beyond and other perpetual retail memes such as AMC, Gamestop, Blackberry, etc are all witnessing strong double-digit increase in their share prices over the past month.
One will need to recognize there are 2 broad themes in play with these “meme stocks”. The first is social media and the second is underlying business operations. Let me elaborate.
Social Media
The media, and consequently the transfer of information used to be dominated by the big boys a decade ago. Not anymore.
With the proliferation of social media platforms such as Twitter and online communities such as Reddit, retail investors now have substantial “clout” over the information transmitted through the web that anyone with the internet can access.
They look to target stocks with the potential for outsized moves, or what is now more commonly known as “meme stocks”.
These meme stocks have a few common characteristics:
- There could be a high level of short interest in the counter
- The company has got a low free float volume, or
- There could be a sudden interest in the company by a celebrity or famous investors
Take for example the rally in Bed Bath and Beyond just last evening. This catalyst many are using to explain the move is Ryan Cohen, the founder of Chewy, an e-commerce company focusing on pet care, who is also the chairman of Gamestop, the King of meme stocks.
An SEC filing showed that in April, his firm took a bullish position in Out-of-the-money (OTM) calls with strikes between $60 and $80 expiring in Jan 2023.
Note that back in April, BBBY was trading at approx. $15-$20/share, not far off from the current post-rallied price of $20/share. This could mean that those options might still be “underwater”.
On that news, the stock was up nearly 80% last evening but closed up a mere 29%.
Might there be further upside? Time will tell but I will suggest a way in which I might look to partake in this “meme craze” the safer way, at the end of this article.
Underlying Business
The second theme is the possible change in underlying business dynamics from a credit standpoint. You see, the stocks’ activity has given many of these companies a much-needed lifeline.
They were previously “left for the dead”, abandoned by shareholders and creditors. With their price now regaining “signs of life” and presumably at a much higher level than what it used to be, many of these companies are taking the “god-sent” opportunity to sell more stocks or debt at prices they wouldn’t have been able to before.
This will buy them more time to turn around their actual business. Take for example Gamestop. Post its meme-fuelled rally, the company issued 5m shares to raise a total of $1.1bn in June 2021. This equates to $220/share or the current post 4 for 1 split equivalent price of $55/share.
It wasn’t that long ago that its shares were still trading at one-tenth of that price, at the start of 2021.
With the capital raised at a high price, Gamestop’s fundamentals, in terms of its credit situation, now seem “better”.
That’s partially why most of these stocks did not crash back to the same prices they were before they became “meme stocks” and rallied a ton.
While the traditional media likes to characterize anyone trading these stocks as gamblers, and maybe they are, but there might perhaps be some logic behind the movements of the stocks based on the two broader themes above.
Finding meme stocks to squeeze
I don’t advise this to be done for most retail investors, not unless you are prepared to lose your capital. However, for those who wish to have some excitement in their life, you could perhaps find some of these highly shorted meme stocks that might be ripe for a “short squeeze”
I have previously written a detailed article on how one might be able to find these short squeeze candidates in this article:
Most shorted stocks. A smarter way to play the short squeeze game
Back in May/June, the market has been particularly bearish on the back of high inflation numbers and hawkish moves by the Fed. Sophisticated market participants probably expressed their bearish bets by shorting the worst of the lot.
However, market sentiments have improved significantly over the past month and these highly shorted stocks are now getting squeezed.
BBBY is a prime example of that, with close to 30m shares being shorted vs. outstanding shares of c.80m
Once there is a spark, momentum will feed on itself and many retail investors will jump on to ride on this trend until it breaks.
Speculating the “safer” way
In all honesty, there is no safe method to speculate on these highly volatile meme companies.
The most basic rule is not to bet on capital that you cannot afford to lose.
However, one can reduce that capital outlay significantly through options, just like what “big boy” Ryan Cohen is doing.
For myself, I am potentially looking to partake in stocks like BBBY, demonstrating strong upside momentum through short-term OTM call options.
Note that these are highly speculative plays with a low probability of profit but with strong asymmetrical risk vs. returns.
In the case of BBBY, I could be purchasing a call option on BBBY, expiring on 16 Sep, with a strike price of $26, paying approx. $600/contract.
The most I lose in this “bet” is the $600 I paid as a premium. Most of the time I will set a Stop loss at 50%, which means my theoretical risk level is just $300
But if BBBY’s rally has “legs” with its momentum continuing, I could generate a nice high double-digit or even triple-digit return on my capital within a pretty short period.
Do note that this is not a recommendation to be buying into BBBY, either through its shares or through its options.
Conclusion
We all love some excitement in our lives and one way to satisfy that is perhaps to partake in the rally with the common “man-in-the-street” and stick it to the big boys. However, as I have cautioned multiple times, if you are going to play, make sure you only risk what you can afford to lose.
History has shown that for every big winner in these stocks, there are a lot of losers too.
And you should be clear about your strategy. Engaging a “Diamond hands” approach will often lead to tears, in my view.
If you wish to stick to your tried and tested “passive” investing approach because that allows you to sleep well at night, that is all fine. Sit back, grab some popcorn, and watch the market’s amazing moves over the coming days.
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Disclosure: The accuracy of the material found in this article cannot be guaranteed. Past performance is not an assurance of future results. This article is not to be construed as a recommendation to Buy or Sell any shares or derivative products and is solely for reference only.
