Dril-Quip (NYSE:DRQ) has been range-bound for the past several months and I expect the trend to continue with a bias to the upside going into the earnings call on Oct. 26. Specifically, there are two plays with a slightly bullish bias in DRQ stock that I want to share with you, as each play could lead to impressive profits.
Houston-based DRQ — which operates in the oilfield equipment and services (OFS) industry — designs, manufactures, sells and services equipment for offshore drilling. Several of its competitors include Baker Hughes (NYSE:BHGE), National Oilwell Varco (NYSE:NOV) and Superior Energy Services (NYSE:SPN).
Like its competitors, Dril-Quip has suffered from falling oil prices as well as the downturn in offshore drilling equipment and services. However, as oil prices continue to improve, the business environment is beginning to look brighter for the industry.
2018 Q2 saw DRQ come up with robust quarterly results and year-to-date (YTD), the stock is up over 4.5%. Analysts highly rate the strong operational performance of management, the cash-rich and debt-free position of the company, and the technological leadership of Dril-Quip. Its earnings are expected to grow at about 20% yearly, a significant number for the industry. DRQ stock’s relatively small-cap of $2 billion and strong financial position have also increased the rumors that it may be an acquisition candidate by a larger energy firm.
As October investing is already seeing sector rotation, a bullish offshore narrative is likely to support Dril-Quip and prevent a decline in share price amidst a potential broad market sell-off. DRQ stock’s 52-week price range has been $37.35 (Oct. 26, 2017) — $58.95 (July 18, 2018). Dril-Quip’s technical chart is still exhibiting range-bound price moves. Short-term support for DRQ is ﬁrst at $48.70 and then at $47.30; meanwhile, short-term resistance in Dril-Quip stock is ﬁrst at $50.60 and then at $53.
If you believe that DRQ is likely to stay within a range with a slight possibility of a breakout to the upside, here are the two trades set up for DRQ stock (prices are based on Dril-Quip stock’s closing price of $49.92 on Oct. 8):
Two Plays on Dril-Quip Stock
1. Use an in-the-money covered call covered call, whereby you would buy 100 shares of Dril-Quip stock at a limit price of $49.92 and, at the same time, sell a DRQ 21 Dec $45 call option, which currently trades at $7. The $45 option is slightly ITM, offering more downside protection in case of increased volatility in DRQ stock, especially around the earnings call.
This call option would stop trading on Dec. 21 and expire on Dec 22.
Assuming you would enter this covered call trade at the closing prices on Monday, at expiry, the maximum return would be $2.08 (i.e., ($7 – ($49.92-$45))*100), excluding trading commissions and costs.
An ITM covered call’s maximum profit is equal to the extrinsic value of the short call option. The trader realizes this gain as long as the price of DRQ stock at expiry remains above the strike price of the call option (i.e., $45).
At expiry, this trade would break even at a DRQ stock price of $47.84 (i.e., $49.92-$2.08) excluding trading commissions and costs.
2. Sell the 21 Dec $45 put option with a limit price of $1.50 — its closing price on Oct. 8.
This put option would also stop trading on Dec. 21 and expire on Dec 22.
Assuming you enter this put selling strategy at the closing prices it had on Tuesday, the upside is that you keep the premium as long as Dril-Quip stock closes above $45 when the option expires (excluding trading commissions and costs).
The downside is that if DRQ stock trades below $45 ahead of expiration, you could be assigned 100 shares for each sold put at the cost of $45 per share.
At expiry, this trade would break even at a DRQ stock price of $43.5 (i.e., $45-$1.5).
The Bottom Line on DRQ Stock
I expect Dril-Quip stock to continue trading within a range with a possible upside bias. However, as prudent investors, it is always crucial to maintain a clear risk/return profile. Thus, a break out to the downside occurs, mid to low-$40’s level could be the next leg down.
As of this writing, Tezcan Gecgil did not hold a position in any of the aforementioned securities.