Our Favorite Stock in the Cybersecurity Space

The following is a reprint of the market commentary from the March 2015 edition of The Option Advisor, published on February 26. For more information or to subscribe to The Option Advisor, click here.

Just within the past year and a half, the number of major corporations that have fallen victim to cyberattacks is nothing short of alarming. By now, quite a few brands that U.S. consumers interact with on a daily basis have earned this dubious distinction -- including Target (TGT), Home Depot (HD), Amazon.com (AMZN), eBay (EBAY), Anthem (ANTM), and Sony (SNE) (with the last of these enduring what might be the most bizarre iteration of the by-now-familiar tale).

So perhaps it was inevitable that November 2014 brought us the launch of the PureFunds ISE Cyber Security ETF (HACK), an exchange-traded fund based on the companies that swoop in to provide damage control and preventive services for those targeted by hackers. HACK, with its on-the-nose ticker, settled at $25.10 on its first day of trading, and more recently has been testing its mettle around the $30 level.

Meanwhile, speculative interest on HACK has exploded -- and primarily on the call side of the equation. At year-end 2014, total open interest on HACK was fewer than 1,000 total contracts, with only 628 calls and 169 puts outstanding. As of Feb. 26, those figures had climbed to 3,812 calls and 636 puts. In other words, during a period of time in which HACK gained about 10%, open interest on the fund surged 458%.

Taken out of context, that factoid may make it seem as though the HACK bandwagon has quickly erupted from virtually nonexistent to bulging at the seams -- but note that total open interest is still at a relatively low absolute level, which suggests that we may yet be in the early innings of this particular trend.

In fact, among HACK's top 10 holdings is relative newcomer FireEye (FEYE), which appears to have the near-textbook makings of an Expectational Analysis ^® play. The company has been called in to address some of the higher-profile corporate hacking cases, including the Sony debacle, and the shares have gained nearly 44% in value year-to-date (with just under two full months of trading on the books).

Yet against this backdrop of strong demand and breakout price action, there are signs of significant skepticism toward FEYE. For starters, a full 45% of analysts maintain a "hold" or "sell" rating on the stock, and the average 12-month price target of $43.35 is south of FEYE's current price.

Elsewhere, we find 15.7% of FEYE's float in the hands of short sellers, following a nearly 7% increase during the most recent reporting period -- a two-week stretch of time during which the shares advanced some 25%, flying in the face of this steady selling pressure. And finally, options traders are similarly unimpressed, with Schaeffer's put/call open interest ratio (SOIR) for FEYE arriving at 0.97, in the 98th annual percentile.

The takeaway from all this -- in addition to the likelihood of further additional upside from FEYE, from our perspective -- can be whittled down to: context matters. A surge in option open interest on a buzzed-about sector like HACK might incite knee-jerk feelings of skepticism among seasoned contrarians (and justifiably so, in some cases). And indeed, not all of HACK's top holdings are winners. A look at the price action in KEYW Holding (KEYW), for example, certainly doesn't inspire any bullish confidence.

When it comes to FEYE, however, the stock is hardly crumbling under the weight of lofty expectations. For those intrigued by the prospects for cybersecurity firms, this is one stock that's backing up the hype with its solid performance.