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Are Shorts Playing It Safe on Diamond Foods?

Traders have been buying DMND calls at a rapid pace in recent weeks

by 6/6/2012 11:15:36 AM
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Calls are becoming the options of choice on Diamond Foods, Inc. (DMND - 20.40), according to data from the major exchanges. During the past 10 sessions, speculators have bought to open 4,929 calls and 1,248 puts on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) -- pointing to a strong preference for bullishly oriented options on snack food purveyor DMND.

In fact, DMND's 10-day call/put volume ratio of 3.95 ranks higher than 79% of comparable readings taken over the past year, confirming that traders have purchased calls over puts at an accelerated clip in recent weeks. Over this same time frame, for the record, the stock has shed nearly 12% of its value.

The recent trend toward bullish bets over bearish may have been inspired by a rare dose of positive news for DMND, which has plummeted 71% over the past 52 weeks amid an accounting scandal. On May 23, the company announced a $225-million investment from Oaktree Capital Management -- providing a much-needed boost to DMND's balance sheet.

DMND SOIRTaking a longer-term look at option-buying trends, DMND sports a 50-day call/put volume ratio of 3.54. Not only does this reading indicate that calls bought to open have more than tripled puts in recent months, it also registers in the 96th percentile of its annual range. In other words, speculators have shown a greater bias toward calls over puts only 4% of the time during the past year.

As a result, the security's Schaeffer's put/call open interest ratio (SOIR) is wallowing near annual-low territory. The current SOIR of 0.44 reveals that calls more than double puts among options expiring within three months, and it ranks in the 6th percentile of its annual range -- suggesting that short-term speculators have rarely been more call-heavy on DMND.

However, call buyers could have an ulterior motive. Short interest dropped by 5.6% during the most recent reporting period, but still accounts for a top-heavy 54% of the equity's float. At DMND's average daily trading volume, it would take more than three weeks for all of these shorted shares to be unwound.

Given this hefty supply of short interest, it's possible that bears have been buying calls on the stock in order to limit their upside risk -- particularly in light of Oaktree's recent investment, news of which sparked an intraday gain of more than 7% for DMND on May 23.

The shorts probably don't need to panic just yet, though. Due to its dramatic swoon on the charts, DMND is staring up at any number of potential resistance levels. While the stock is testing a tentative foothold atop the round-number $20 level, it's also trading just south of its 10-week and 20-week moving averages. These trendlines have smacked the shares lower since last October, and resistance here shows no signs of weakening.

 Weekly Chart of DMND since September 2011 With 10-Week and 20-Week Moving Averages

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