Trade Idea: Discount on Dollar Tree Options

01/12/2018 9:28 am EST

Focus: STOCKS

Elizabeth Harrow

Director of Digital Content, Schaeffer's Investment Research, Inc.

Trade idea: DLTR has historically been a very rewarding target for option premium buyers. The stock sports a Schaeffer’s Volatility Scorecard (SVS) of 100, the highest possible reading, says Elizabeth Harrow, at Schaeffer's Investment Research.

Retail stock Dollar Tree (DLTR) has bounced back in a big way from its summer 2017 lows around the $66 level. The shares have gained about 66% since then, with plenty of room to keep climbing before they bump into “double low” territory around $132.

DLTR is fresh off a new record high of $111.69, in fact -- and it seems as though there may be more upside yet to come before this rally is over.

Schaeffer’s Senior Quantitative Analyst Rocky White notes that front-month implied volatilities on DLTR options are hovering right around 21%, which ranks in the 4th annual percentile.

Since 2008, there has been just one other occasion where DLTR volatility has been this low while the stock simultaneously traded within 2% of its annual high -- and following that prior signal, the stock was up 4.3% one month later.

Guggenheim begins coverage on Dollar Tree.

Granted, it doesn’t get much smaller than a sample size of one.

Shown on the accompanying chart, DLTR has enjoyed the near-infallible support of its 20-day moving average since last July. Plus, a recent period of consolidation brought the equity’s 14-day Relative Strength Index (RSI) down into the 65 range, effectively working off an early December overbought condition.

chart

Perhaps most compelling for contrarians is the steady flow of short-covering support DLTR has garnered. Short interest fell by roughly 8% in the most recent reporting period, but the current supply of shorted shares is still equivalent to about three times the stock’s average daily trading volume.

A continued capitulation by these underwater shorts could contribute to additional gains in the short term.

Trade idea: Meanwhile, it should be noted that DLTR has historically been a very rewarding target for option premium buyers. The stock sports a Schaeffer’s Volatility Scorecard (SVS) of 100, the highest possible reading -- which means the equity’s realized volatility has consistently outpaced the implied volatility priced into its options during the past 12 months.

With short-term vols near annual lows and trendline support firmly intact, it's a prime time to take advantage of the generous returns offered by DLTR options.

View Schaeffer’s Investment Research for stock and options ideas, options education, and market commentary here…

Related Articles on STOCKS