Last week the meme traders struck again. Many people ignore them. I do not, because they can present you with profitable opportunities.

But first let talk about meme stocks. A meme stock is a stock that can see its trading volume and price soar on the basis of posts on social media and online forums. Often there isn’t a good fundamental reason for the surge. GameStop (NYSE: GME) became an early example of this phenomenon in 2021, and I highlighted a profitable trade in GameStop at that time. (See Our Low-Risk GameStop Trade).

So, a company whose price surges because of hype sounds exactly like the kind of company you want to avoid. In fact, I detailed the trade I am going to discuss below on Facebook, and someone responded “Meme stocks? You might as well go to the casino.”

But this answer fundamentally misunderstands the opportunity that can arise when meme traders send the volume of a stock surging.

Be the Casino

It is true that if you are trying to profitably buy and sell meme stocks, you might as well go to the casino. The share price can whip back and forth with tremendous volatility. You could see 100% gains one day and 70% losses on another day. This isn’t the basis for a sound trading strategy.

But, what happens when volume and volatility surge? Option premiums also surge. When option premiums surge, it can be very profitable to sell options. In this way, you aren’t the gambler in the casino. That’s the meme trader. You are the casino.

Here was the scenario last week. The reason this scenario was unique, is that I have owned Bed, Bath, and Beyond (NSDQ: BBBY) since 2018. It’s not a company I would recommend today, as it has some serious financial challenges. The only reason I still hold it is that I have sold enough calls on my position to work the cost basis down to a very low level.

In fact, I acquired my shares for about $19.50 a share in 2018. On Friday they closed at $11.03/share. Seemingly, I have lost 44% on this trade. But that’s inaccurate.

Since 2018 I have sold calls on my position totalling $17.95 a share. So, my cost basis for these shares is approaching zero. It should go negative the next time I sell a call, which means I will profit even if BBBY goes bankrupt.

BBBY opened last week at about $14 a share. Enter the meme traders. I won’t get into the background of the reasons it happened, but on Tuesday, the meme traders had driven shares to $28. It was a headline story on CNBC. In the option screens at Fidelity, BBBY topped the list for implied volatility (IV), which in turn means the option premiums are soaring.

I checked option prices during the trading day on Tuesday. When I checked, shares were trading at just over $26.00. I could sell a call option with a strike price of $25 expiring on September 16 for $9.15 a share. That is a phenomenal option premium (37% of the strike price) for a 30-day holding period. I own 500 shares, so I sold five options for $4,571.49 (after commissions).

I had to consider whether the meme traders might drive shares to $100. They have done that before. But, my main consideration was taking another huge chunk out of my cost basis. The strike at $25 would do that.

Cashing in My Chips

By Friday, shares had plummeted. The calls I sold for $9.15 on Tuesday were only worth $0.83 a share on Friday because of the plunge in BBBY shares. I had realized over 90% of the profit potential in three days, and 30 days prior to expiration. So, I bought them back, netting $4,153.09 in three days.

Thus, my “cost” was only $0.83 a share, and my sales price was $9.15. Of course I did those out of order, which is what you do when you sell options and then buy them back. You can figure the profit a number of different ways, but $0.83 to $9.15 is over 1,000% in three days. Of course that trade doesn’t consider the underlying change in the value of the stock itself, but that’s another story. It was a wild ride last week for sure.

You might ask why I closed the trade early, since I could have gotten the full $9.15 if I let the trade go until expiration. Simple. I had already gotten over 90% of the potential profit, and closing the trade early gives me an opportunity to repeat the trade should the opportunity arise.

This opportunity was unique because I already owned shares. But if you own shares of a company that suddenly becomes a meme stock (or, for that matter sees its shares soar for any reason), you can do the same. Of course, you could simply sell your shares when they rise, but I prefer to hold them and sell options over and over again.

An Alternative Trade

An alternative — and the basis of last year’s GameStop trade — would be to sell a cash-covered put on the company. In this case, that could have meant selling a put far below the price of BBBY, which minimizes the risk of assignment. For example, when shares were trading at $26, you could have sold a put with a $10 strike price and a January expiration for $3.30. That’s a 33% return on your money for a 4-month holding period.

Of course, you must understand the potential obligations of these trades. When I sold the covered call on my shares with a strike price of $25, that obligated me to sell my shares for $25 should the price go higher. If meme traders had sent the share price of BBBY to $100, then I would still have to let my shares go for $25. That’s the risk the option purchaser is taking. They are the gambler in the casino.

With the put trade, you will be obligated to buy shares at the strike price should the share price fall below that. If you sold a $10 put for January, and shares are at $5 then, you still have to pay $10 (although that cost would have been offset by the $3.30 premium you received).

One important caveat: You should never sell “naked” options. Always own either the underlying security when selling calls, or have cash in your account when selling puts. That substantially derisks this type of trade.

In any case, don’t ignore the meme traders. Whenever you hear that the price and volume of a stock has soared, check those option premiums. You may be able to open up a casino and cash in.

Editor’s Note: Perhaps the trading strategies just described by my colleague Robert Rapier are too risky for your taste. If you’re looking for a way to generate steady income with reduced risk, consider our premium trading service, Rapier’s Income Accelerator, helmed by Robert.

Robert Rapier can show you how to squeeze up to 18 times more income out of dividend stocks, with just a few minutes of “work” each week. His income-generating system is safe and pays off like clockwork. Click here for details.