Seeking Alpha
Long/short equity
Profile| Send Message|
( followers)  

On Thursday, one of our readers asked my opinion on holding DRYS options through their earnings announcement, and I had to give my frank opinion -- that it was simply too dangerous given the current market sentiment.

I think the trader was disappointed to hear that and had been hoping for a bigger win after the announcement, considering that much of the market seemed to expect good numbers from DryShips. But sector conditions seem to require caution still.

If you've been following my shared trades on the shipping sector, you will know that my current strategy is:

  1. Buy calls at or before the announcement of the earnings release
  2. Sell them the morning preceding the earnings release, somewhere near about 10:30am
  3. If you want to try to parlay the play further, move the money into equity instead, and set a GTC stop loss order to protect profits, and try trading in the after hours

Here's my rationale. Because of the price declines and widespread loss of dividends in the shipping sector, valuation has dropped out and there is not the usual price protection one can expect of an stock with a solid dividend. Instead, the names are being supported by speculator money, which is not interested in making the stock a long term hold. Speculator money is short term money, and therefore there is not the normal buildup of support one can usually expect from an improved earnings report. DRYS in the last 3 days is a perfect example.

Despite its propensity to outrageous shareholder dilution, DRYS remained the volume leader of the shipping sector, and a positive buzz about its earnings was attracting new money, causing the price to rise slowly. The announcement was made after the market close on Thursday, and it was a fairly good one, causing the price to shoot up to $7.23.

Under usual conditions, the stock would gap up the next day and a new uptrend would begin, but instead the stock sold off violently and fell to close under $6.60, with a continued downtrend the next day.

Clearly, any holder of options could have found themselves with a disappointing loss. What happened? Most of the money in the stock was highly mobile, and speculators now wanted to withdraw their profits in order to put the money to work elsewhere. This started a fast selloff. Longer term money was too weak and failed in its attempt to support the stock at the new price level.

Holding equity through the earnings announcement would have been a better play. With the equity, manual trading could have protected the investor in the after hours, and a GTC sell order might even have caught the spike up over $7, resulting in a nice profit.

When should the options position have been sold? I had to chop off the pre-earnings day chart to make it fit, but sure enough, the stock price had peaked at 10:30am Thursday morning, and that would have been the ideal spot to cash in the options.

You can see what this means for DRYS: It's not good. On the chart, look at the volume spike at the opening, indicating that an enormous number of people bought the stock as it was being dumped by the speculators, and those people mostly paid $6.90-6.95. That price zone, full of unhappy new stockholders, is now a new resistance area. DRYS will not easily or quickly penetrate it to go to $7 now.

Shippers are still one of the most oversold sectors in the market, in my opinion. But being oversold is not enough to make them good for the medium or long term. The sector needs one or two dividend reinstatements to really begin strengthening. That could happen this quarter, but I doubt it.

In the meantime, keep in mind the 3-step strategy outlined above, and remain extremely cautious. Good luck!

Written by Skymist

Source: DryShips: Speculator Money Still Pervades Sector