Options Corner: Looking for the Heat in the Hot Sectors, Part II
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April 25, 2008
This sounds like a lot of work, but you’ll be surprised just how simple it is.
For this week’s case study, our stock is DO (Diamond Offshore Drilling). Firstly let’s look at a stock chart of DO within ProfitSource.
Chart 1
click here for more detail
This stock is of course bullish. The only two indicators I have added are the Oscillator, which is currently showing good momentum to the upside, and the Range Projector (placed on the previous high – the 5 point in Dec 2007) to give an idea of where the stock is likely to move to next.
Now let’s check the sector of the stock which in this case is the DJ US Oil Companies Secondary Index (see Chart 2).
Chart 2
click here for more detail
Without any indicators on the chart, we can see that this sector is bullish. No one knows if it’s going to go up from here but looking at it historically, it is bullish. So far DO is a bullish stock in a bullish sector.
Let’s now turn to the fundamentals.
Firstly let’s look at the Dividends per Share as well as Earnings per Share for DO using fundamental analysis software, ValueGain.
Chart 3
click here for more detail
Both the Earnings per Share and Dividends per Share are increasing and tracking well above the industry average. We could stop here knowing that the stock, sector and underlying fundamentals are strong, but there is another easy to use tool that all traders (options, CFDs or shares) would find tremendously beneficial.
We will now check the SuperValue Calculator in ValueGain to see if our stock is undervalued. Look at the green line on the below chart. The green line is the average of all the different pricing models, which all give a fair value of the stock. If the stock price is lower than the green line, then we know the company is undervalued, which is a bullish sign.
Chart 4
click here for more detail
As you can see, DO is also undervalued. All it took was a glance at the SuperValue Calculator, no maths, no searching on the internet, no reading through prospectuses and company balance sheets.
So for our case study, let’s go to the final step and construct an options trade on Diamond Offshore Drilling (DO), assuming our criteria has been met so far.
The actual entry point of the trade will always be a personal thing. For instance looking back at Chart 1, you may choose to wait until the stock has completed wave 3 and retraced down to wave 4, or you may wish to wait until its broken through previous resistance (of which there is only one previous high) but you may miss out on a lot of upside, or you may have a favorite set of indicators to help you time your entry.
The last step in the process is to use OptionGear software to construct the trade. OptionGear is a vital part of the ProfitSource suite. Directly from ValueGain or ProfitSource, I clicked on ANALYSIS then NEW ANALYSIS, which took me to the options chain.
There are some great trade scanning features in OptionGear however I constructed an OTM Bull Call Spread by handpicking the options from the chain. I started with a Long Call two strikes Out Of The Money, and then sold another Call another two strikes away. I did 3 contracts to keep my trade size to as close to $1000 (or less) as possible. The multiple contracts will also allow some nice adjustment opportunities along the way. Once the options were selected and I shaved the price modestly, I clicked on GRAPHS to view the Risk Graph of the Bull Call Spread.
Chart 5
click here for more detail
I hope you can see how simple it is to find trading opportunities out there. The last ingredient is good trade management!
Keep it simple
Matt Baker
Trading Tutors Team
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