Sometimes, the best way to make money in the market is to invest in companies others hate. Other times, riding a wave of popular support higher is the prudent move. Today, there’s an opportunity to do a bit of both.
Dana Inc. (DAN) is one of the most well-known names within the automotive industry… but not all that visible to those outside of it. The company doesn’t make cars, trucks or SUVs. But it makes the stuff that those automobiles need to move.
The company manufactures everything from driveshafts to hydraulic pumps. It has deals with the Ford, Daimler and Nissan to produce all of the parts those companies put in their vehicles. And this behind the scenes parts supplier role has worked out for Dana for more than a century.
It is one of the oldest and most well-established players in this field. But as you know, this field is rapidly changing. The move from gas-guzzling cars, trucks and SUVs to electric, hybrid and even automated vehicles is the story of these days. But that doesn’t mean an old company like Dana can’t learn a few new tricks.
It’s been keeping up, and doing so quite well, with the transformations in the industry. It has been out there in the mergers and acquisitions market for a long time consuming companies that specialize in e-Motors, battery cooling and software systems.
It has incorporated those new technologies that are only increasing in demand into its wide portfolio of products. And those moves have only increased the company’s bottom line and backlog.
Yet, as with all companies in the automotive industry, Dana has seen its share price slide for a while now. From the start of 2018, until mid-December, DAN shares dropped as much as 61%.
So, this would appear to be a contrarian play if you were to go long on the company’s future prospects. But that too has changed recently.
This morning, the company announced its fourth quarter and full-year earnings. Shares are up by more than 10% just today. And investors have been preempting this news since they found DAN’s bottom in December. Since its low, Dana’s stock is up about 46%.
This latest release confirmed what many started suspecting during this recent rally: Dana is not some decrepit relic from Detroit’s past. It is still a dynamic player… one that is actually growing at a pretty impressive clip.
Its recent acquisitions have helped the company grow its top and bottom line for a while now. And it is expected to continue that growth. In 2018, revenue jumped 13% and earnings per share rocketed 310% after a down 2017. It also announced guidance that points to double-digit growth continuing throughout all of 2019.
This performance has allowed the company to grow its dividend and shore up its balance sheet. In short, the company is doing well. But since shares fell so hard last year, they remain cheap… even after the recent rally. DAN trades at just 6.6 times its 2018 earnings.
And if the company delivers on its projected 2019 figures, that’s a forward P/E of just 6. That’s about as cheap as any stock in the market.
So, it should go up. Nothing in this market, however, suggests it will go up. Such a hard bounce and double-digit post-earnings performance could signal too fast of a recovery.
Investors have clearly had trouble pricing DAN for quite some time. Trading as high as $32 and as low as $13 without any significant changes to the business means they just don’t know where it should be.
And that’s the only real sure thing we can tell about DAN. Volatility will remain high. In fact, if there’s any boom in profit-taking from this recent rally, share prices should bounce around quite a bit in the next month or two… if not longer.
Fortunately, there’s a way to play that volatility.
A Strategy To Profit From Volatility
One of our favorite strategies to use when we find a company like Dana is called a long straddle. On the surface, it doesn’t sound like it makes any sense.
But it is actually a brilliant way to profit on a company that you know will move in a big way but just not which direction. In fact, it is about the only way to make money on such a situation.
The way a long straddle works is by using both a put and a call to leverage movement in either direction. To enter a long straddle, a trader needs to buy a call option with a strike price right where the stock’s current trading price is. Then, he has to buy a put option with the same exact strike price and the same expiration date.
See, it doesn’t sound logical. Why bet on both a bullish outcome for a stock and a bearish one? But you can see how this works:
Source: The Options Industry Council
Sure, it costs money to enter this kind of trade (it’s a net debit spread). But if the underlying shares move enough, it quickly reaches profitability. But one of the most important parts of this trade is that those profits are limitless. If shares keep going up… or down… the trade just reaps a higher and higher return.
With a company like this one, that can move more than 10% in a day and experience swings of -61% and +46% in just a few months, this is the right strategy. Let’s look at a specific trade idea.
A Specific Trade on DAN’s Volatility
To play DAN using a long straddle, a trader could buy a March 15 $19 call for $0.83 per share and buy a March 15 $19 put for $0.70 per share for a net debit of $1.53 per share. Since each of those options represent 100 shares of DAN, that’s a total entry cost of $153.
That $153 is the most the trader has at risk here. Even if shares don’t move a penny in either direction in the entire month of this trade, that’s all he would lose.
Now, that might still sound like a bad trade. But consider this: if shares move even a fraction of today’s action in the entire next month, this trade will give the trader a nice return.
And if shares keep going in either direction even further, which has been the case over the last 18 months, that return just grows and grows.
In fact, as mentioned above, there’s really no limit to how much this trade could put in the trader’s pocket.
To find the point of that profitability – the exact price shares of DAN need to hit before this trade turns into a profit – simply apply the cost to the strike price.
For instance, if Dana’s stock rises, it would have to pass $20.53 per share ($19 + $1.53 = $20.53) to reach a profit. If it falls, it needs to drop below $17.47 per share ($19 – $1.53 = $17.47). In both directions, that amounts to a total price movement of 8.1%.
As we noted, the stock has moved 46% over the last two months… and more than 10% today. 8.1% is not a large move for DAN. And this is the best potential trade if this volatility stays high.
— The Option Specialist