"Check Six": Aviator parlance for watching your backside.
DryShips Inc. (NASDAQ:DRYS) closed Tuesday's trading session at $3.48. In the past year, the stock has hit a 52-week low of $1.75 and 52-week high of $5.12. DryShips stock has been showing recent support with a double-bottom pattern around the $2.00 level and has skyrocketed 74% year-to-date. Technical indicators for the stock are bullish. A recent earnings miss coupled with a revenue beat has lead to some interesting trading and increased option volatility. For a quick hedged play on DryShips, take a look at the following short-term trades:
1. Covered Call: The DRYS Mar '12 $3.50 buy-write can be executed for a net debit of approximately $3.29. That is also the break-even stock price for this trade. This covered call has a duration of 18 days, provides 5.46% downside protection and an assigned return rate of 6.7% for an annualized return rate of 129.4%. Banking the $0.19 time premium over 18 days is the reason for such a high annualized rate of return.
2. Collar: Combine the DRYS Mar '12 $3.50 buy-write with a long DRYS Mar '12 $3.00 put for a net debit of approximately $3.37. That is also the break-even stock price for this trade. The collar trade has a duration of 18 days, provides 3.16% downside protection and an assigned return rate of 4.15% for an annualized return rate of 78.2%. While this trade provides a lower return and downside protection than the covered call, it will cap losses at a stock price of $3.00, where the trader loses $0.37 per contract or 11.8% on the initial investment. This is a good trade to make if the investor is bullish, but nervous about the stock gapping down below $3.00.
3. LEAPS Calendar Spread: A lower-cost hedged play for DryShips would use a longer term call option in place of the covered call stock purchase, such as a LEAPS option. The investor creates a calendar spread by selling a shorter-term call option for premium and downside protection. You really don't need to use this strategy to save capital costs, unless you are looking to increase leverage and want to remain in the trade for several months to sell multiple call strikes. To use this strategy look at going long the DRYS Jan '13 $2.00 call and selling the Apr '12 $3.50 call for a total debit of $1.38. The trade has an initial lifespan of 53 days and would provide 13.8% downside protection and an assigned return rate of 8.7% for an annualized return rate of 59%.
If the stock price exceeds the strike price of the short option before expiration, you might want to consider closing out the entire position. If you do get assigned on the short call, don't make the mistake of exercising the LEAPS call. Sell the LEAPS call on the open market so you'll capture the time value (if there's any remaining) along with the intrinsic value. Simultaneously buy the stock to cover your newly created short stock position. A good broker who understands options can help you through this process. Keep in mind the additional risk that LEAPS, unlike stock, eventually expires, so it's possible to lose the entire value of the initial investment.
DryShips Inc. does not currently pay a dividend.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.