Video Game Maker Stumbles As a Rival Soars
Some products are more competitive than others. A classic example could be Coke and Pepsi. Many consumers have a preference for one or the other, but many consumers will accept either if they are at a fast food restaurant.
In addition to having a high degree of changeability, the products are also both parts of a large market. There is enough demand for soft drinks that both companies can do well over the long run. But, that’s not true for all markets.
In the video game market, for example, the potential market size is large. But, the truth is that players do have limited resources and will not be able to dedicate unlimited time to each game they buy. That means some companies will suffer when others prosper.
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For now, one of the hottest trends in video games is Fortnite, and news related to that game could be pressuring the stock of a rival game maker.
Fortnite Pressures Take-Two
Millions of players are enjoying Fortnite but the biggest news could be, as Reuters reported, that Epic Games, the creator of video game sensation “Fortnite”, said on Friday it received $1.25 billion in funding from investors, including KKR & Co Inc, Iconiq Capital and Smash Ventures.
This news comes as a publicly traded game maker, Take Two Interactive Software (Nasdaq: TTWO), is experiencing volatility.
“Fortnite,” a sort of hybrid of “The Hunger Games” and “Minecraft,” drops 100 people onto an island to fight each other for survival.
The tactical tournament game, whose first version was released in 2017, has been called an industry “game-changer” by analysts as it signed up tens of millions of users for its last-player-standing “Battle Royale” format.
Epic Games is valued at almost $15 billion as part of the new investment round, the Wall Street Journal reported on Friday, citing people familiar with the matter. The company declined to comment on its valuation or any plans to go public when contacted by Reuters.
Epic, which counts Tencent, Walt Disney Co and Endeavor among its minority shareholders, was estimated to be worth $4.5 billion by Jefferies analyst Tim O’Shea in May.
Rival video game makers Activision Blizzard, the creator of “Call of Duty,” and “Grand Theft Auto” owner Take-Two Interactive lost billions of dollars in market value earlier this year as investors took note of Fortnite’s ability to wring cash from players.
Take-Two’s products are designed for console gaming systems, such as PlayStation 3 and PlayStation 4; Xbox 360 and Xbox One, and personal computers, including smartphones and tablets.
Rockstar Games is the developer and publisher of Grand Theft Auto, as well as other franchises, including L.A. Noire, Max Payne, Midnight Club and Red Dead. 2K publishes owned and licensed titles across a range of genres.
A Trading Strategy to Benefit from Weakness
A price decline often results in higher than average options premiums. That means option buyers will be forced to pay higher than average prices for trades, But, sellers could benefit from the higher premiums.
In this case, with a bearish outlook for the short term, a call option should be sold. The call should decline in value if the stock declines and sellers of calls benefit from this decline.
Selling options can involve a great deal of risk. A spread options strategy can be used to limit the potential risk of the trade.
One strategy that traders can consider is the bear call spread. This is a trade that uses two calls with the same expiration date but different exercise prices.
Traders buy one call and sell another call. The exercise price of the call you sell will be below the exercise price of the long call. The call is sold to limit the risk of the trade. So this strategy will always generate a credit when it is opened and will always have limited risk.
The risk profile of this trading strategy is summarized in the diagram below which shows the limited risk and reward.
Source: The Options Industry Council
While risks and rewards are limited, this strategy will allow traders to generate potential gains in a stock they might otherwise find too risky to trade. Many individuals ignore bearish strategies because of the risks.
You’ll know the maximum potential gain with this strategy as soon as it’s opened. It is equal to the amount of premium received when the trade is opened. The maximum loss is equal to the difference between the exercise price of the options contracts less the premium received and is also known.
A Bear Call Spread in TTWO
For TTWO, we could sell a November 16 $123 call for about $9 and buy a November 16 $125 call for about $8.10. This trade generates a credit of $0.90, which is the difference in the amount of premium for the call that is sold and the call.
Remember that each contract covers 100 shares, opening this position results in immediate income of $90. The credit received when the trade is opened, $90 in this case, is also the maximum potential profit on the trade.
The maximum risk on the trade is about $110. The risk can be found by subtracting the difference in the strike prices ($200 or $2.00 times 100 since each contract covers 100 shares) and then subtracting the premium received ($90).
This trade offers a potential return of about 82% of the amount risked for a holding period that is about five weeks. This is a significant return on the amount of money at risk. This trade delivers the maximum gain if TTWO is below $123 when the options expire, a likely event given the stock’s trend.
Call spreads can be used to generate high returns on small amounts of capital several times a year, offering larger percentage gains for small investors willing to accept the risks of this strategy. Those risks, in dollar terms, are relatively small, about $110 for this trade in TTWO.
These are the type of strategies that are explained and used in our TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your income and wealth building goals, click here for details on Options Insider.