DraftKings Is Worth a Bet After a Punishing Pullback

Shares of DraftKings (NASDAQ:DKNG) are finally finding some footing after a sharp sell-off. DraftKings stock fell more than 30% from the mid-June highs near $42 before bouncing off support.

DraftKings (DKNG) logo, magnified, on its app.
Source: Lori Butcher/Shutterstock.com

Certainly, some of the drop was warranted given the red-hot rally that preceded the pullback. Now the selling has come too far, too fast.

Look for DraftKings stock to get back on a winning streak over the coming months.

I was bearish in my previous post on DraftKings stock from June 5. Shares were trading near $42 and euphoria was running rampant.

I noted that DraftKings stock was extremely overbought and that the options market was displaying a reverse skew. A reverse skew means that out-of-the money calls trade at a higher implied volatility (IV) then similar out-of-the money puts.

Normally puts carry a higher IV, so a reverse skew is yet another sign of upside euphoria. I recommended selling a bearish call spread to take advantage of this euphoria, which proved to be profitable.

A look at the option prices shows that the skew is now back to a more traditional relationship. The 5-point out-of-the money puts now trade at a higher IV level than the similar 5-point out-of-the money calls. The frothiness evident with DraftKings stock near all-time highs has been wrung out. This is a contrarian bullish sign.

DraftKings (DKNG) skew montage
Click to Enlarge
Source: The thinkorswim® platform from TD Ameritrade

My previous post on DraftKings stock showed just how overbought DKNG as it traded at all-time highs. In a similar vein, the most recent chart shows just how oversold DraftKings has gotten currently. Nine-day RSI hit the lowest levels ever with a reading below 30. Shares have subsequently strengthened on that metric.

MACD also got to the most oversold levels before it too turned higher. Bollinger Percent B went negative before turning positive. There is major downside support at $27.50.

DraftKings (DKNG) six month chart
Click to Enlarge
Source: The thinkorswim® platform from TD Ameritrade

Most importantly, DraftKings stock had a key reversal day yesterday. Shares opened lower and traded all the way down to the key $27.50 area before pivoting to close higher on the day. This type of price action is many times a sign that the previous trend has come to an end. The sellers have become exhausted and the buyers have taken charge.

It is especially powerful since it occurred at a major support level following a prolonged sharp sell-off. I expect DKNG to bounce over the short term.

Matt McCall and the InvestorPlace research staff echoed a similarly guardedly bullish tone in their recent report. They were longer-term bullish on DraftKings stock but wouldn’t necessarily buy at current levels.

McCall noted the increased competition and comeback of novel coronavirus concerns as a reason to be bullish but wary. I agree with that thesis and would use the options market to position to be a buyer on a further dip. Implied volatility still remains very high so option selling strategies are favored. Selling a longer term out-of-the money put makes probabilistic sense.

Trade Idea for DraftKings Stock

Sell DKNG Jan $20 puts at $2.75

Selling these puts will bring in $275 worth of option premium up front. The seller is obligated to be a buyer of DraftKings stock at $20 less the premium received which equates to a $17.25 net price. This is below the $17.60 all-time low. It is also nearly $13 points (42%)  below the $30.22 closing price of DKNG. The $2.75 premium received equals a 16% return on the $17.25 at risk or 34.56% annualized.

As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or for a weekly option and volatility newsletter can visit the Options and Volatility Newsletter website.

Article printed from InvestorPlace Media, https://investorplace.com/2020/07/draftkings-is-worth-a-bet-after-a-punishing-pullback/.

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