DraftKings (NASDAQ:DKNG) is gearing up for its third earnings report since debuting in the public markets earlier this year. Buyers made a recent comeback and have prices heading higher ahead of Friday morning’s festivities. To prepare you for the event, we’re breaking down the price action in DraftKings stock and analyzing what the Street is pricing in.
Volatility has hounded the stock since its April IPO. But wicked whipsaw and rapid booms and busts are common for freshly minted stocks. In their infancy, companies carry a higher risk/reward profile, which translates into greater uncertainty and thus volatility. Only spectators with a higher risk tolerance should participate.
As DraftKings finds its footing and gets a handful of earnings reports under its belt, we should see a steadier trend and more stable movement arrive.
DraftKings Stock Chart
The past quarter has seen quite the roundtrip. Consider it a mini boom-bust cycle. After nearly doubling from $35 to $64, prices came full circle back to $35. As a result of the massive rug-pull, the once-promising breakout over $44 officially failed, creating a monster bull trap. It’s unfortunate. September’s surge was accompanied by a slew of accumulation days showing institutions and other big buyers wading into the waters. The amount of participation signaled that the breakout was legitimate and likely to last.
But sometimes signals fail.
Buyers quickly swarmed in September, but they fled even faster in October. Death-dealing distribution killed the uptrend by pulling prices back beneath the 50-day moving average. In a single swing, DKNG fell from $64 to $35. The selling pressure was relentless and makes me question the sustainability of the current rebound attempt.
But sentiment can turn on a dime if the earnings announcement delivers. There’s nothing like a solid earnings beat to send bears back to their hidey-hole. In the near-term, prices need to push back above $44 to clear the breakout zone and return DKNG to an uptrend.
Options Expectations
Forecasting the direction of tomorrow’s gap is foolhardy, but we can easily estimate the move’s size by analyzing the options market. The prices traders are paying for calls and puts implies how much DraftKings shares should move once the sales numbers hit the wires. With DKNG at $41.30, premiums are baking in a move of $3.24. That could be up or down and translates into a rise (or fall) of 8%.
Compared to the outsized volatility we’ve seen over the past three months, 8% doesn’t seem like all that much. Remember, the stock nearly doubled and then halved over the past quarter. The relative expensiveness of options makes spread trades a better bet if you want to swing a directional play into the event.
Here would be my preferred trades for bulls and bears into tomorrow.
Bull Trade: Buy the Dec $45/$50 bull call spread for $1.30.
The low cost translates into a fantastic risk/reward. Your loss is limited to $1.30, but if DraftKings stock can rise past $50 by expiration, the potential gain is a tasty $3.70. That’s a 284% return.
Bear Trade: Buy the Dec $40/$35 bear put spread for $2.
Though not as asymmetric as the bullish idea, this spread still boasts a 150% return by risking $2 to make $3. The downside target is $35, which is entirely realistic if the price stumbles after earnings.
Forget Direction, Exploit the Volatility Crush
For those wishing to sidestep guessing direction, there is a third alternative. You could build a high probability position designed to game the rapid drop in implied volatility, which should accompany the earnings gap. Because DKNG has already fallen so far from its highs, I’m inclined to sell puts over calls.
Vol Crush Trade: Sell the Dec $30 put for 55 cents.
On the date of publication, Tyler Craig did not have (either directly or indirectly) any positions in the securities mentioned in this article.
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