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It's a zombie stock apocalypse but at least the spreads are cheap - CHK, HTZ, AMC
4 min read

It's a zombie stock apocalypse but at least the spreads are cheap - CHK, HTZ, AMC

It's a zombie stock apocalypse but at least the spreads are cheap - CHK, HTZ, AMC

Overview

  • Everyone's trying to figure out the odd price action in stocks that have recently declared bankruptcy or are at risk of declaring bankruptcy soon.
  • Some examples, Hertz (HTZ), Chesapeake Energy (CHK) have both experienced insane short squeezes. AMC Entertainment has rumors swirling.
  • What is the options market pricing and how can they be best used?

The Set-up

First, let's look at the 1 month expected moves from OptionsAI technology, most of these stocks are pulling back a bit today:

Hertz (HTZ)

Chesapeake (CHK)

AMC Entertainment (AMC)

Obviously, all of these stocks have different stories and different scenarios of how their restructuring would play out. But that's neither here nor there when traders are looking to gun them higher for a quick profit. Markets aren't exactly efficient in scenarios like this.

The options market can be efficient, but sometimes the math can get a little out of whack. One look at the HTZ expected move and you'll notice something that happens rarely in a stock. A potential short squeeze, priced up 100%... and a stock being worth zero. With a stock like this, both have to be priced equally, because the options can't price a move past zero.

That sets-up for one of my favorite inefficient market options trades, using ZERO as the third 'strike' on a bearish range trade. Turning the Zero into the third wing on a butterfly.

Ways to Play

YOLO Bullish - But before I get to that, let's start with one for the YOLO crowd and use AMC with I don't know, a $10 price target, using OptionsAI technology. Why not?:

I mean, they're not crazy considering what's going on. If you want to spend a little money on a lotto ticket in the case that AMC squeezes like HTZ or CHK... there are some rewards there. I wouldn't do it often. But there's a reason people go to Vegas.  It's fun. Just make sure you get your free cocktail before the dealer pulls a 21 after showing a 5 face up.

But this is an example (as I've identified in prior posts in the Airlines) where the options market has a difficult time pricing straddles because the one side is zero while the other side is infinite. In AMC's case that means the OTM calls get overpriced versus the ATM calls. The straddles can't get priced past the price of the stock (you won't see a $5 stock with a straddle more than $5) so we see weird demand in other strikes.

Nerdier Bearish - Speaking of straddles that can't go past zero... now the nerdier fun. I'm sure some people are trying to figure out how to short some of the back from the dead zombie stocks. They're probably getting smoked doing it. And a simple glance at the options market isn't much help. Puts are jacked, with breakevens that need the stock to go to zero... just to make money.

But... what happens in a lot of these scenarios is the skew for OTM options gets so out of whack that ratio spreads set-up for (fairly) cheap trades to the downside.

Here's an example in HTZ, with a July 17th expiration:

The 5 puts are trading roughly $3.15. That's a breakeven of $1.75 in the stock. You basically need the stock to go to zero and you're risking a lot, like a third of the stock price.

But! The 2.5 puts are trading roughly 1.40. As a spread that's much better, but even better than a simple vertical spread is a ratio one because it offloads almost all of the premium risk, and here's the key point, because the stock cannot go below zero, it does not have the normal risk of a ratio spread, it acts more like a defined risk butterfly.

Here's how it would work with those puts, if you were to buy one of the 5 puts for 3.15 and sell two of the 2.5 puts at 1.40 that would be a 1x2 put spread for .35.

Because the stock cannot go below zero, it acts like a 5/2.5/0 put butterfly. (as if you own the zero put for nothing). The most that can be lost on that trade is .35, (that happens if the stock finishes above 5, or exactly at zero on July 17th.) Anything close between $0.35, and $4.65 in HTZ on July 17th and the trade is profitable. If the stock is near $2.50, the trade can make up to $2.15 in profits (it can be worth up to $2.50.)

You can play around with the strikes to find other versions. The rule here is the long strike, and short strike need to be the same distance from each other, as they are from zero.

For instance, the 3/1.5 1x2 put spread is about .25 and the 4/2 1x2 is about .40. You can go fishing with a lower bid to get the risk closer to zero. I've seen scenarios like this where you can buy these for .05 or .10.

I looked just after the open and similar trades were available in CHK but much wider, then the stock was halted. The key here is puts are priced as if these stocks could go to zero and therefore it's almost impossible to make money simply buying a put (would you buy the 5 put in HTZ for $3.15?, of course not). This 1x2 spread can act like a butterfly and establish a wide range of potential profitability below.

See a part of OptionsAI technology with your own price target and demo trades in AAPL HERE

Previously:

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