Trade Idea: XRT and GME

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I’m going try to keep this short and succinct.

I think there’s an opportunity to short GME as we near the end of March.

Why?

Because the S&P retail ETF XRT needs to rebalance in the third week of March and it is currently heavily overweight GME due to its meteoric rise in this quarter. Back in September 2022, GME made up only 2.1% of the ETF’s holdings. With GME at over $200, it currently comprises almost 15% of the fund with 475,632 shares held.

XRT aims to track S&P’s retail stocks index, and we see that no stock in the index should have a weight more than 4.5% of the index:

“If necessary, a final adjustment is made to ensure that no stock in the index has a weight greater that 4.5%. This step of the iterative weighting process may force the weight of those stocks limited to their maximum basket liquidity weight to exceed that weight.”

We see that when XRT rebalances, they need to sell at least 70% of their GME holdings to not cross the 4.5% threshold, and possibly more. 70% of 475,632 shares is a little over 330,000 shares, which is $86.5 million and more than double GME’s average daily volume of $37.8 million in the last 5 days. The reader should also keep in mind that this selling is just selling from XRT. There are no doubt other ETFs or mutual funds that might also need to rebalance out of GME at the end of the quarter.

How do we know when XRT is rebalancing?

We see this straight from their prospectus:

The market capitalization threshold and the liquidity threshold are each reviewed from time to time based on market conditions. Rebalancing occurs on the third Friday of the quarter ending month.

What’s the best way to short GME?

The safest way to short GME is to buy puts, which is non-recourse leverage. However, the premiums of GME are extremely high right now, so you should buy a debit put spread to try to remain as IV neutral as possible but also cap your gains. An example of a debit put spread is buying a $200 4/2 put and selling a $150 4/2 put. Your max gain for this trade is $50 - cost of the spread, while your max loss is just the cost of the spread.

This is a risky trade idea. GME behaves unpredictably and it’s possible that it continues to appreciate before crashing. However, the odds appear to favor the downside as we near the end of March. GME is already starting to teeter this week and assuming S&P doesn’t change their ETF rebalancing schedule or strategy, GME is likely to fall under $200 by month end.