Not all fun and games with video game maker
10/19/17

In trading as in life, everyone’s got opinions. It’s easy to forget that every time a trade is made, someone else is on the other side of it. Trading opportunities would be hard to come by without this dynamic, and the story that unfolded these past few days with video game maker Electronic Arts (NASDAQ: EA) certainly would not have happened either. Here’s what’s going on…

On Tuesday EA announced in a blog post that they are changing which internal unit of the company would produce the upcoming “Star Wars” game.1 Early Wednesday morning a Morgan Stanley analyst digested this information and decided to lower his price target on EA due to the delay in the release date of the game.2 The stock price dropped at opening on Wednesday. 

Electronic Arts (EA) 10/13/17–10/18/17

Source: OptionsHouse by E*TRADE

However, not everyone shared that pessimism. Following the initial sell-off, bullish options traders did a swan dive into an options position on the stock in case it bounced back:

  • They bought 4,500 EA November 115 calls for $3.35.
  • And concurrently sold 4,500 EA November 125 calls for $0.77.
  • Taken together, the net position is long a Nov 115-125 call spread for $2.58 ($3.35 + $0.77).

By owning the call spread, they profit if EA stock rises before the November expiration. The risk/reward options graph for this position looks like this:

Electronic Arts (EA) call spread risk/reward

Source: OptionsHouse by E*TRADE

The traders who bought this call spread have defined risk, meaning they can only lose the $2.58 that they paid for the spread. If EA were to continue to decline, their losses are limited. The maximum profit they can potentially make is $7.42, which is the difference between the strike prices less what they paid for the spread ($125 – $115 - $2.58 = $7.42). So the upside potential of this spread is also defined. To break even, the traders need EA to rise the amount they paid for the spread above the $115 strike, which is $117.58 ($115 + $2.58 = $117.58).

EA reports earnings on October 31, before expiration. This adds an additional dimension to this position. While it’s the opinion of some traders that a delay in the release of the “Star Wars” game will be detrimental to EA’s stock price, it’s the differing opinion of other traders that EA’s earnings might be better than expected, which could drive EA’s stock price higher. While it remains to be seen whose opinion is correct, on Halloween it’s either going to be trick or treat for these traders.

 

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1. MarketWatch: EA shuts down studio developing 'Star Wars' game. 10/17/17.

2. TheFly: Morgan Stanley lowers Electronic Arts price target to $126 on Star Wars delay. 10/17/17.