Options Update: DryShips’ Call Volume Soars on Hopes of a Dry-Shipping Revival

Shares of DryShips
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have been on a tear during the past 3 sessions, with the stock surging more than 208% from its December 4 low of $3.36 per share.

The equity has vaulted above former resistance at the 10 level today, as traders continue to bet on an improving outlook for the company. Sparking the 3-day buying spree was a report last week which stated that an early resolution to China’s iron ore price negotiations would boost the struggling dry-bulk-freight market, thus lifting dry-bulk shipping companies.

Commenting on the development, Jefferies & Co. said in a research note that “We believe an earlier than anticipated resolution of the 2009 iron ore contract price negotiations could lead to an earlier than anticipated rebound in dry bulk shipping demand.” Furthermore, an analyst with Dahlman Rose said that “A successful downward adjustment to iron ore prices from Chinese steel mills could further stimulate the dry bulk market, however negotiations have only just begun.”

As a result of this speculation on a revival of the dry-shipping market, call activity has been brisk on sector standout DryShips. In fact, the stock’s Schaeffer’s put/call open interest ratio (SOIR) has dropped from a reading of 0.54 on December 3 to today’s perch at 0.52, underscoring the recent preference for calls over puts among speculative options traders.

Furthermore, data from the International Securities Exchange (ISE) and Chicago Board Options Exchange (CBOE) reveals a 10-day call/put ratio of 3.51, meaning that calls bought to open have outpaced puts purchased by more than 3 to 1 during the prior 2 weeks. This reading is also higher than 92% of all those taken during the past 52 weeks, highlighting this extreme bullish nature of this activity.

It should come as no surprise that today’s heavy call volume on DRYS has outstripped the stock’s average daily call volume by a ratio of more than 7 to 1. Looking at our Intraday Volume Explosion List, I noticed that the most active contract was the December 10 strike, which has seen more than 15,000 calls change hands< so far today.

DryShips option volume details

The Anatomy of a DryShips Call Position

Digging into this call activity, I noticed that 1 block of 139 contracts changed hands at 11:03 a.m. Eastern time at the ask price of $2.10. The total outlay for this position would be $29,190 — ($2.10 * 100)*139 = $29,190. For this trade to reach breakeven, DRYS would need to rally about 68% to $12.10 per share from yesterday’s close of $7.17, before the options expire on December 19. The maximum loss on this position is limited to the initial investment of $29,190.

By entering this trade, the investor is indicating that he expects DRYS to rally sharply during the next several weeks. The shares are off to a stellar start, rising more than 45% so far today. That said, let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

As noted above, DRYS’s recent rally has vaulted the shares above former technical resistance at the 10 level. This formerly oppressive region could now provide key support for the shares. However, there are still several hurdles which DRYS must overcome if it is to maintain its upward bias. First, the shares have plunged more than 90% so far in 2008, attaching a bit of a stigma to the equity. Second, resistance at the stock’s 10-week moving average is quickly descending into the region. DRYS has not closed a week above this trendline since mid-August. The 10-week moving average currently rests at 12.22, just above breakeven for the aforementioned December 10 call, and could create trouble for this position.

Weekly chart of DryShips since May 2008 with 10-week moving average

The Sentiment Drivers

However, there are potential sentiment drivers that could help push the equity past this technical hurdle. While options players are heavily bullish toward DRYS, short sellers have placed large bets against a rally in the security. Specifically, short interest increased by more than 16% during the most recent reporting period, resulting in a hefty 21% of the stock’s float sold short. If DRYS can continue its recent momentum, it could spook these short sellers into buying back their bearish bets, thus resulting in added buying pressure for the security.

Elsewhere, Zacks.com reports that 4 of the 6 analysts following DRYS rate the stock a “hold.” Should China actually reach an early resolution in its iron ore price negotiations, we could see Wall Street brokerage firms reassess their negative positions on the shares. Naturally, any upgrades from the analyst community could provide additional upside potential for DRYS.

Sentiment indicators for DryShips

The Verdict?

A call position on such a beaten down stock almost seems like a sucker’s play, especially given DRYS’s meteoric rise during the prior 3 trading sessions. In other words, there is no guarantee that the security will maintain this momentum beyond today’s session. However, with pressures mounting to do something about the growing global economic crisis, China could very well resolve its issues early thus providing the boost for the dry-shipping market that analysts have touted. The potential for positive news on this front, as well as the heavy bearish sentiment levied against DRYS make a December 10 call position quite attractive at this point. Furthermore, traders should keep an eye on the stock’s 10-week moving average, as a break out above this trendline could signal that a longer-term rally may be in the cards.

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