$SPRT - Getting (modestly) Rich from Meme Stocks!

Examining the Risk/Reward of Selling Volatility

Extraordinary Disclaimer

I would like to kick off with this disclaimer because the following idea is quite different in style to my previous posts on the Plum Capital Substack. Please note the following:

• Meme stocks are highly risky due to elevated levels of volatility

• Options are risky, and can potentially subject you to catastrophic losses

• Options on Meme stocks are PARTICULARLY risky for the above reasons combined

Nothing I ever post on the Substack is investment advice. If the following idea makes you uncomfortable, there is absolutely zero shame in sitting this one out and observing from the sidelines. Even for me, this is a relatively small position compared to my core book.

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Introduction

If you asked me what the easiest money I’ve ever made was, I would say hands down selling puts on Gamestop and AMC Entertainment during vol spikes. During the periods of nauseating volatility in GME and AMC earlier in the year, I sold short-duration, deep OTM puts aggressively, and ultimately pocketed the premiums in full as the puts expired worthless. Now you may scoff at this – there were people less sophisticated than me making life-changing money left and right by simply buying the stock (or calls, for that matter) and riding the incredible wave of new highs thereafter. Why am I bragging about those puny put premiums, you may ask.

Well, hindsight is always 20-20 and you can bet your last dollar that I would have piled my net worth into OTM calls if I had a crystal ball. But we live in a probabilistic universe, and I decided to sell deep-OTM puts because I felt that was the only trade that made sense from a risk/reward standpoint from an ex-ante basis. So while I did not get unfathomably rich like the Roaring Kittys and the Senvests of the world, I did pretty well for myself, generating spectacular IRRs and reinvesting the proceeds into my core positions.

I think one of my strengths as an investor is being able to “connect the dots” and find recurring patterns in the markets. It is my current belief that there is a recurring source of alpha here, and indeed I have executed the same playbook successfully in many a meme stock – i.e. selling puts during days of extreme volatility. The following is a list of names for which I have made significant PnL in the past:

• GME

• AMC

• CLOV

• WISH

• APHA

• GEO

Therefore, the recent almighty spike in the share price of Support.com Inc. (NASDAQ: SPRT) captured my attention, and I believe the vol-selling playbook can effectively be applied here again.

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Business Overview / Situation Overview

Support.com is a small-cap BPO company that provides various outsourced customer support offerings and cloud-based technology platforms to clients in several industry verticals – including media, telecommunications, healthcare, retail and technology. Typical customer support functions include voice, chat and self-service offerings, through their network of remote employees and cloud-based platforms. This is a pretty subscale business with poor historical profitability, and I suspect that public market investors are more familiar with SPRT from the impending merger with Greenidge – a green-energy Bitcoin miner with lofty expansion goals:

I am not going to do a deep dive into the business model or attempt a detailed valuation exercise on the PF business. I trust that interested subscribers can do their own work, and I’d maybe point people to a summary of the situation I found on Seeking Alpha (linked here) – though I am not explicitly endorsing the author or speaking to the accuracy of the content, I merely thought it was a good starting point.

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Arguments for Selling Volatility

By the time that a company has established its position in the meme world, I would argue that it is already too late to speculate by taking a directional bet – because on the long side, you are typically buying a business trading far north of its intrinsic value, while the short side is perhaps even more dangerous as calling the top is almost impossible (our friends at Melvin Capital would concur). I am not smart enough to predict short term price action of meme stocks, or any security for that matter, so I am not going to play a game where I have no edge.

However, selling vol through deep OTM puts is a completely different proposition. You are making a bet that the stock price will not fall below a certain level by a certain date, and the risk/reward is highly sensitive to the premium amount, and where the option strike is relative to current stock price and intrinsic value. But taking a step back, I think short duration, deep OTM puts with fat premiums are generally very interesting, especially for meme stocks. As for the reasons:

1. Keynes famously said that the market can remain irrational longer than you can remain solvent. Indeed, looking at the trading history of various meme stocks in the past 12 months, we see that the prices do not immediately tank following a meme spike – they fall back to earth of course, but the decline curve is often far more gradual than you might expect – and in many cases, the stock trades far in excess of pre-meme prices for many months thereafter.  

2. Technical dynamics become very relevant, as shorts often drive the price action – speculators become wary of shorting anywhere near the pre-meme prices, and the new shorts entering after the meme spike become natural buyers down the road, as they cover to book profits (again, typically at prices far above where the stock traded pre-meme status).

3. Dip buying is also a relevant factor, as speculators realize that a stock that has squeezed once has good potential to squeeze again in the future (we’ve seen this pattern with GME, AMC and many others). So there are often buyers stepping in on dips to speculate, which cushions the downside and makes it less likely that the stock mean-reverts to the pre-meme price.

4. Companies and management teams are not dummies – many have taken advantage of the meme spikes to sell stock at highly, highly inflated valuations, which can seriously de-risk the balance sheet and provide optionality going forward, which then justifies the higher stock price to a certain extent

All well and good, but I’m sure skeptics will still want to dismiss the above arguments. So I am going to provide some hard data. What I’ve done below is aggregate the prominent meme stocks that have captured the market’s attention in the past 12 months. I’m sure I missed out on a few, but I think there are enough names here to make averages and medians meaningful:

Let’s focus on what is important. Of the ~30 names listed above, the median stock price decline from the meme top tick is ~62% in 3 months – but even so, that price is still 25% higher than where the stock traded pre-meme! I think this is pretty remarkable. And numbers get even crazier with the averages, but of course there are significant outliers (such as GME) so it’s more instructive to look at the medians.

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Trade Setup

I think selling SPRT OTM puts offer compelling risk/reward at current prices. Of course every part of the options chain has a slightly different risk profile, so you have to choose the strike and the expiry that you are most comfortable with. I have no strong view on what the best combination is, but let’s just look at December puts with a $10 strike purely as an illustrative example:

As can be seen from the above tables, if the stock falls less than 73% by Opex, we will make the full premium, which is a very attractive yield on the capital that needs to be set aside assuming full assignment of the puts. IRRs are amazing as well, given that Opex is just over 3 months away. For us to start losing money at Opex, the stock needs to fall more than 81% from current prices - as the put premiums provide three dollars of further downside protection.

Now, I’m not saying that Dec $10p is my preferred trade. I am just showing this as an example, and you can lower the strike or shorten the duration as you wish to create a safer trade, by giving up the size of the premium and the yield on offer (and vice versa as you move up the strike and further out on Opex).

Finally, there is no rule to say that you have to hold until expiry. In fact, I suspect that premiums will collapse in the very near term as the eventual IV crush nears – which is bound to happen as the crayon-eaters and “apes” lose interest in SPRT and move onto the next hot meme stock. I plan to monitor the trading levels and cover the short puts as soon as the juice no longer justifies the risk/reward of having this exposure on.

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Conclusion

Let’s not forget that this is a risky trade, but I still believe that the juicy premiums on offer make this interesting from a risk/reward standpoint. But I will highlight the fact that this is a small position, and I have all the cash available to meet the assignments if the trade does not work out for me. This is very important, as selling naked puts means that you are at the risk of getting terrible fills if you ever happen to be liquidated.

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Disclosure

Plum Capital is short SPRT deep OTM puts of various strikes and expiries