Barron's - USA (2020-10-19)

October 19, 2020 BARRON’S M5

THE STRIKING PRICE

Our previous recommendationto buy Smith &

Wesson’s September $10 call options when the

stock was at $9 produced a return above 100%.

How to Play the Surge

In Gun and Ammo Sales

G

un sales are surging, and so are

the stock prices of major gun

and ammunition companies.

The demonstrations and

looting in Portland, Ore.; New York City;

and elsewhere have scared people. Ammu-

nition, rifles, shotguns, and pistols are

now hard to buy, according to numerous

reports. Tactical gear like chest rigs that

carry extra magazines and battle equip-

ment are also hard to find.

We were early to recognize that 2020

would be an exceptional year for gun sales

because so many people were afraid of

civil unrest. In late April, we advised in-

vestors to bullishly tradeSmith & Wes-

son Brands(ticker: SWBI) andSturm

Ruger(RGR), as the surge in gun sales

wasn’t yet part of the national dialogue.

Now those fears have since become a

major national story, and demand for guns

and ammunition shows no signs of abating

whether President Donald Trump or for-

mer Vice President Joe Biden wins the

election. September was the sixth straight

month of more than 50% year-over-year

growth for federal background checks. It

is time to reset our positions.

The usually moribund Smith & Wesson,

Ruger, andVista Outdoor(VSTO), which

makes ammunition, are among the year’s

best-performing stocks.

Our previous recommendationto buy

Smith & Wesson’s September $10 call

options when the stock was at $9—at the

time, the company was called American

Outdoor Brands—produced a return ex-

ceeding 100%. Smith & Wesson makes

a popular, and not expensive, AR-15 rifle.

(Calls give the buyer the right to buy the

underlying asset at a set price within a

specified period.)

The recommendation to buy Ruger’s

October $55 calls when the stock was at

$54.50 has also been profitable. We would

recommend taking profits and not reset-

ting the trades, if it weren’t for the con-

tinuing social anxiety about the future that

seems likely to keep gun sales brisk.

Aggressive investors should focus on

Smith & Wesson’s calls that expire in Jan-

uary and Vista’s calls that expire in Febru-

ary. Pick strike prices that equal or slightly

exceed the stock price. The trades mone-

tize the seemingly insatiable demand for

AR rifles and ammunition.

Consider Smith & Wesson. The stock

is up 134% so far this year. Shares are up

218% over the past year.

With the stock trading at $16.69, inves-

tors can buy Smith & Wesson’s January

$17.50 call for $2.45. The trade will break

even if the stock is above $19.95 at expira-

tion. At $25, the call is worth $7.50. During

the past 52 weeks, Smith & Wesson’s stock

has ranged from $4.24 to $22.40.

Without a doubt,the suggested trade is

extremely aggressive. In the options mar-

ket, Smith & Wesson’s January $17.50 im-

plied volatility is about 85%. This means

that the market is pricing the stock as if it

will move 5.3% each day until the option

expires on Jan. 15.

Options volatility measures the options

market’s expectations for how a stock will

behave in the future. To contextualize

Smith & Wesson’s options volatility, note

that the implied volatility of the S&P 500

index is about 22%.

The discrepancy between the market

benchmark and Smith & Wesson stock is

significant, and it reinforces the red-hot

nature of the stock.

Many investors prefer to sell options

with elevated implied volatility as a way

to monetize the fear or greed premiums in

the options market, rather than paying top

dollar to trade an option. Yet there are

times when it makes sense to focus more

on the stock and less on options dynamics.

Now is one of those times with Smith &

Wesson—if one believes that the demand

for gun stocks will show no sign of abating

through the January expiration.B

By Steven M. Sears

Equity Options

CBOE VOLATILITY INDEX

VIX Close VIX Futures

10

30

50

70

90

ND J FMAMJ J ASO

Daily Values Source: CBOE

THE EQUITY-ONLY PUT-CALL RATIO

Put-Call Ratio S&P 500 Index

40

60

80

100

120

140

160

180

200

220

240

260

280

300

320

ND J FMAMJ J ASO

Source: McMillan Analysis Corp.

SPX SKEW

Implied volatility %

8

9

10

11

12

13

14

15

16%

ND J FMAMJ J ASO

Source: Credit Suisse Equity Derivatives Strategy

NDX SKEW

Implied volatility %

8

9

10

11

12

13

14

15

16%

ND J FMAMJ J ASO

Source: Credit Suisse Equity Derivatives Strategy

Skew indicates whether the options market expects a stock-market advance or decline. It measures the difference

between the implied volatility of puts and calls that are 10% out of the money and expire in three months. Higher

readings are bearish.

Week'sMostActive

Company Symbol TotVol Calls Puts AvgTotVol IV%ile Ratio

Loop Industries LOOP 16684 5823 10861 420 99 39.7

Surface Oncology SURF 3284 2586 698 160 76 20.5

Del Taco Restaurants TACO^21935188703065106891 20.5

Allscripts Healthcare MDRX 8614 3531 5083 448 92 19.2

Huttig Building HBP 2169 1179 990 120 31 18.1

AnaptysBio ANAB^2219152069912856 17.3

Sleep Number SNBR^263451630210043164066 16.1

Waddell & Reed WDR 10807 10215 592 760 94 14.2

Cyclerion Therapeutics CYCN 2400 1671 729 180 41 13.3

Gossamer Bio GOSS^83996937146264439 13.0

Concho Resources CXO 67622 34963 32659 6116 78 11.1

Dillard's DDS 30425 12038 18387 3988 84 7.6

Vertex Pharmaceuticals VRTX^28830190769754425697 6.8

Infosys INFY 28725 24869 3856 4512 71 6.4

Huya HUYA 44758 29851 14907 7376 39 6.1

Liquidia Technologies LQDA^711746542463116491 6.1

Zynex ZYXI 11646 8263 3383 1992 27 5.8

VOXX Int'l VOXX 7166 4641 2525 1256 90 5.7

Moneygram MGI 16265 14885 1380 2984 46 5.5

Dick's Sporting Goods DKS^859738059553781627647 5.3

Thistableofthemostactiveoptionsthisweek,ascomparedtoaverageweeklyactivity–notjustrawvolume.Theideaisthatthe

unusuallyheavytradingintheseoptionsmightbeapredictorofcorporateactivity–takeovers,earningssurprises,earningspre-

announcements,biotechFDAhearingsordrugtrialresultannouncements,andsoforth.Dividendarbitragehasbeeneliminated.In

short,thislistattemptstoidentifywhereheavyspeculationistakingplace. Theseoptionsarelikelytobeexpensiveincomparisonto

theirusualpricinglevels.Furthermore,manyofthesesituationsmayberumor-driven.Mostrumorsdonotprovetobetrue,soone

shouldbeawareoftheseincreasedrisksiftradinginthesenames

RatioistheTotVoldividedbyAvgTotVol.IV%ileishowexpensivetheoptionsareonascalefrom0to100.

Source:McMillanAnalysis