How to Take Advantage of a Pricing Anomaly in Aterian Options

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Aterian (NASDAQ:ATER) stock looks to have finally found some footing after a big-time pump and dump. Shares in the consumer product platform went parabolic to trade over $48 in early February.

Source: Shutterstock

Then the selling started in earnest and Aterian fell more than 90% and traded down to nearly $3 post earnings in August. Since then ATER stock has regained some of that massive loss.

Certainly much of that ridiculous rally to start the year was following on the meme based short squeeze footsteps of Gamestop (NYSE:GME) and AMC Entertainment (NYSE:AMC). Now that ATER stock has returned to some semblance of sanity, the real question is where does the stock go from here.

InvestorPlace contributor Thomas Niel recently took a deep dive into the pros and cons of buying ATER stock around the $10 level. Niel noted the challenging fundamentals facing the company longer term. He also noted that the high levels of short interest and continued chatter on Reddit’s r/WallStreetBets could potentially set up for yet another short squeeze in Aterian.

The Finance Headline ranked ATER stock as the fourth-most likely short squeeze candidate. Its rankings are based on a combination of short interest percentage, days to cover, and borrowing fees.

Interesting to note that short interest has increased sharply from just under 20% on Sept.15 to over 30% this week. Borrowing fees are also at extremes of over 80%. So, another short squeeze attempt might be in the offing.

Technical Take On ATER Stock

It is a decidedly mixed bag for Aterian looking at the charts. The bulls can take some comfort in the fact that ATER is still holding above major support level at $8 area. This level was breached significantly post earnings but has since been retaken.

The nine-day relative strength index is back to a neutral reading at 44. Momentum is neutral as well.

The bears could point out that moving average convergence divergence did just generate a sell signal. ATER stock is also trading at a big discount to the 20-day moving average at $11.53. Shares continue to see a series of lower highs, which is another bearish sign.

Source: The thinkorswim platform from TD Ameritrade

Implied volatility in ATER stock options is at extremely high readings. The current IV is well over 200, putting it at the 79th percentile. This means option prices are very expensive on both an actual and comparative basis.

The combination of a lower-priced stock with a zero lower bound, expensive borrowing rate and extreme implied volatility provides an opportunity to take advantage of an option pricing anomaly for those who think the worst is over for ATER stock.

Normally, out-of-the-money option spreads trade at a lower price than in-the-money spreads. This makes intuitive sense since option pricing is based on probability. Out-of-the-money spreads are intrinsically worthless. In-the-money spreads carry intrinsic value.

This follows the same reasoning as individual options. In-the-money options are obviously worth more than out-of-the-money options.

Let’s look at Proterra (NASDAQ:PTRAas an example. The stock closed at $9.52 on Monday, or exactly the same price as ATER.

The November $7.5/$5 put spread (out-of-the-money) was priced at 45 cents. The November $7.50/$10 call spread (in-the-money) was priced at $1.2. The implied volatility in PTRA options stood at roughly 105. That’s still high, but only half the extreme IV of 210 for ATER options.

Source: The thinkorswim platform from TD Ameritrade

This pricing makes sense since there is a much greater probability that the in-the-money call spread will be worth something at expiration versus the out-of-the money put spread.

Now let’s take a look at ATER stock options with the same expiration and strike prices. Both ATER and PTRA closed at the same price Monday, ($9.52) but the option pricing is dramatically different.

Source: Source: The thinkorswim platform from TD Ameritrade

The out-of-the money $7.50/$5 put spread  in ATER is priced at $1.075 while the in-the-money $7.50/$10 call spread is just 85 cents. Compare that to the pricing for PTRA options that have the same maturity, strikes, and underlying strikes and you can see the dramatic divergence.

The combination of extremely high IV, a low-priced stock and expensive borrowing fees sets up ideally for a risk reversal trade for those who think the downside is somewhat limited for ATER stock over the coming weeks.

How To Trade It

Buy ATER Nov $7.50/$10 call spread and sell ATER Nov $7.50/$5 put spread for a 20 cents net credit.

Maximum gain is $270 per spread if ATER stock rallies just 48 cents (5%) and closes above $10 at Nov. 19 expiration. Maximum risk on the trade is $230 if ATER stock drops $4.52 (47%) and closes below $5 at expiration.

Margin requirement is $230 per risk reversal. The standstill return is $2.02 (87%) if ATER stock remains unchanged at November expiration.

On the date of publication, Tim Biggam did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Tim spent 13 years as Chief Options Strategist at Man Securities in Chicago, 4 years as Lead Options Strategist at ThinkorSwim and 3 years as a Market Maker for First Options in Chicago. Tim makes weekly appearance on TD Ameritrade Morning Trade Live, CBOE TV Vol 411, Business First AM Trader Talk and bi-monthly appearances on Bloomberg TV Options Insight to discuss options and volatility. Tim has also been invited for reoccurring appearances on CNBC’s Volatility Playbook.

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