Trying to figure out the (sometimes) booming video game industry can be frustrating. There are so many moving parts and fasting evolving trends, getting a grip on what to expect is near impossible. Yet, clearly, there’s an enormous amount of money moving through it.
For companies like Activision Blizzard Inc. (ATVI), the challenge is even more difficult. The company has its hand in every pie. But it’s clear that with how quickly gamer preferences change, this strategy isn’t a perfect one.
You see, Activision is made up of three distinct brands, or segments. First, you have the self-named Activision group – maker of the Call of Duty franchise, which has been going strong for more than a decade and a half. This group lives and dies by this franchise, ordinarily. But in the first quarter of this year, it released the second-best seller of 2019 so far in Sekiro: Shadows Die Twice, overshadowing a weak COD launch.
Next is Blizzard, with its cult following. World of Warcraft, Hearthstone and Overwatch dominate their respective genres. And all stem from the decades-old Blizzard brand.
Finally, ATVI is also a major publisher of mobile games – the fastest-growing segment in the gaming industry. It produces Candy Crush-branded titles under the company’s King Digital group.
Now, with more money pouring into the gaming industry than ever before, you’d think a company like this one would be doing very well. That was true for a time, including last year’s record performance. But that growth has fizzled out.
Of course, others are suffering too with an extremely weak quarter in total game sales. But Activision is possibly in the worst shape. This quarter – set to be released Thursday after the market closes – will show a sharp change in fortune for the company.
The main reason for this expected drop off in performance is due to gamer options. Competition has heated up, with the ever-diluted battle royale market stealing gamers away from Blizzard’s Overwatch franchise and Activision’s Call of Duty one. And if you’ve ever browsed iTunes or Google Play, there’s no shortage of mobile titles to choose from.
On top of that, the company is doubling down on the future of eSports with too much of its future tied to the growth of that market. It recently launched its Overwatch League. This quarter will likely tell investors just how that is going. Most aren’t looking forward to it, however.
All of this is not new information. As you can see, investors have been anticipating a tough 2019 for a while now:
In the time it was watching its stock fall off a cliff, Activision has been trying to shore up its short-term situation.
It has, unfortunately in many investors’ eyes, parted with Bungie the developer of the Destiny franchise – a huge part of why 2018 was so good for the company. That was in January. A month later, Activision announced it was laying off 8% of its staff to cut costs ahead of the expected downturn.
None of this makes Activision sound any more appealing. But it could get worse… particularly after Thursday’s earnings announcement.
Analysts are giving the company every chance they can to surprise them. The average earnings per share estimate for this first quarter is just $0.26. That’s 32% lower than Q1 2018. Meaning investors don’t have high hopes for the company.
Still, Activision itself hasn’t conceded it is doing that poorly. The company is sticking to its guidance of $0.39 for the quarter. That’s a lot of room to fail.
Even if the company presents a better than expected quarter, it will still likely miss its own guidance badly. And investors don’t forgive that… especially right now in the market. Any further cuts to its full-year guidance could send shares down even further.
So, smart money would be ready to short the company ahead of this looming disaster. But even smarter money knows there’s a better way to play it.
A Strategy For Short Term Bears
A bear put spread is a type of trade that involves buying a put option on a stock you believe will fall in price and selling a second put with a lower strike price.
This does two things. It gives you, the trader, the opportunity to cash in on a falling share price. But because you collect an upfront premium for the sold put, you offset your total amount at risk.
This is the exchange for capping your potential profits. But for a trade like the one in Activision right now, that’s worth it.
You can see how this kind of trade looks here:
Source: The Options Industry Council
You see, while Activision is likely to see further share price declines following Thursday afternoon’s earnings announcement, they aren’t likely to collapse entirely. Investors are already wary of the company right now. So, they can’t be too surprised no matter what happens.
Most investors seem to be looking at a relatively small price shock if the company disappoints. A fall to $45 (where it was two weeks ago) or $40 (where it was post-layoffs in February) from its current price of $48 might be the full extent of price action. That makes this strategy the ideal one to take advantage.
Let’s look at a specific example to see what we mean…
A Specific Trade in Activision’s Expected Price Dump
A trader looking to take advantage of this dip in price could buy a June 21 $47.50 put for $2.48 per share and sell a June 21 $45 put for $1.55 per share for a cost of $0.93 per share. Since each represent 100 shares of ATVI, that’s a net debit of $93.
That $93 is the only money at risk for the whole duration of this trade. So, even if Activision vastly surprises all investors and analysts, that’s the most any trader would lose on this particular trade.
To find out how much they stand to make, take the difference in strike prices ($47.50 – $45 = $2.50), and subtract the cost ($2.50 – $0.93 = $1.57)… or $157 total.
That means this trade carries a potential return on the amount at risk of 169%. Remember, this trade doesn’t expire until June 21. So, even a tremendous quarter wouldn’t necessarily spell a full loss.
In the gaming industry, titles and releases are all that matter. If the company suffers another flop or a continuation of weak sales or even a dip in microtransactions, it could still fall in price.
This trade offers a relatively conservative way to cash in on a weak period for this major gaming company. The risk is known up front. And the potential reward far outweighs that risk.