Options Update: Call Volume Soars on Shaw Group Rally

With little more than the rally in the broad market driving the shares, Shaw Group
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has surged more than 11% so far today. The stock has blown past potential round-number resistance at the 20 level, as it looks to challenge its falling 10-day moving average. Following the heavy selling pressure of the past 2 weeks, investors seem to be bargain hunting, and SGR shares are benefiting nicely.

With such a surge in the stock, it was inevitable that options traders would take notice. However, “take notice” may be a bit of an understatement, as call activity for the equity is outpacing SGR’s average daily call volume by a ratio of 15-to-1. This groundswell in option volume has placed the security on today’s Intraday Volume Explosion List, but it was a rather sizeable block of more than 12,000 contracts at the October 20 strike that caught my eye today.

Shaw Group option volume details

The Anatomy of a Shaw Group Call

Taking a closer look at today’s unusual option activity for SGR, I noticed that the large block of 12,972 October calls crossed the tape at the ask price around 9:56 a.m. Eastern time. I’ll use this trade as today’s example. With the block changing hands at the ask price and volume easily exceeding open interest of just 328 contracts, let’s run with a call-buying theme and see how the trade actually plays out:

The trader purchased 12,972 SGR October 20 calls for $1.00, or a total outlay of $1,297,200 — ($1.00 * 100)*12,972 = $1,297,200. For this trade to reach breakeven, SGR would need to gain about 13.5% from Friday’s close to trade at or above $21 per share. We arrive at this by adding the cost of the option ($1.00) to the strike of the purchased 20 call ($1.00 + $20 = $21).

SGR has a nice momentum going in today’s trading, and has rallied more than 11%, leaving a mere 3% between the shares and breakeven for the October 20 call. However, time premium for the trade is slipping away quickly, as October options expire at the end of the week. As such, the trader needs SGR to move quickly above the 21 level before the close on Friday. That said, let’s see exactly where SGR stands from a technical and sentiment standpoint.

Getting Technical

Technically speaking, the prospects for a profitable October 20 call look pretty slim on SGR. The stock is off more than 69% since the beginning of the year, and the shares have been plagued by overhead resistance at their falling 10-day and 20-day moving averages since late June. What’s more, SGR’s falling 10-day trendline resides just overhead at the 22 level. The security has not closed a session above this moving average since September 23, and could find turbulence from any attempt to best this short-term moving average before the end of the week.

Daily chart of Shaw Group since June 2008 with 10-day and 20-day moving averages

The Sentiment Drivers

Sentiment for SGR is heavily bullish, and could be counterproductive for an October 20 call on the shares. Specifically, the stock’s Schaeffer’s put/call open interest ratio (SOIR) of 0.40 indicates that calls more than double puts among near-term options. Furthermore, this ratio ranks below 94% of all those taken during the past year, indicating that options players have been more bullish toward SGR only 6% of the time in the prior 52 weeks.

Meanwhile, Zacks.com reports that 5 of the 10 analysts following SGR still rate the shares a “buy” or better. Given the uncertainty in the market, both domestic and globally, upgrades for this construction company seem increasingly less likely. However, downgrades amid these tough economic times could greatly impact the security. What’s more, Thomson Financial indicates that the current 12-month price target on SGR rests at $57.08 per share – a premium of 67% to the stock’s Friday close. Any downgrades or price-target cuts from these optimistic analysts could provide a renewed round of selling pressure on SGR.

Sentiment indicators for Shaw Group

The Verdict?

Playing a bounce in select stocks and markets at the moment certainly looks like a sound strategy following the past 2 weeks of heavy selling. However, when it comes to SGR, the technical hurdles just above the shares seem pretty daunting. Complicating matters further is that the shares must accomplish this rally before the close of trading on Friday for an October 20 call position to post a profit. While the trader could realize a small gain on a close below SGR’s 10-day moving average by week’s end, ideally, the stock would break-out above this trendline for a sizeable return on the option trade. If you are still bullish on SGR, consider a call in the November or January 2009 series. Personally, I would rather consider a SGR November 22.50 put in an attempt to take advantage of a reversal from overhead resistance in the 22 region.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.