With all eyes on the Iran conflict and its potential global economic consequences, it’s no surprise that the equities market has struggled in recent sessions. In fact, the benchmark SPDR S&P 500 ETF Trust (SPY) recently flashed a rare technical signal. In the trailing 10 weeks, while seven of the weekly candlesticks were positive (green bars), the overall slope during this period was negative.
Frankly, I don’t want to read too much into low-sample-size events. However, of the handful of times that this market structure has flashed since the beginning of 2009, the implications for the S&P 500 have historically been negative. Granted, while there’s nothing about past observations that logically compels a future outcome, the inductive warning does make some sense.
Right now, the market is trying to find its footing. However, with so much uncertainty tied to the Iran conflict, investors are simply sloshing about in the mud. But within this mess, the one sector that could perform well is the broader digital security and observability segment — and that brings us to Datadog (DDOG).
Like other cloud-scale application services and platforms, Datadog has gotten off to a poor start to the new year. Since the beginning of January, DDOG stock has dropped 10%, dubiously earning a 72% Strong Sell rating from the Barchart Technical Opinion indicator. Still, these cloud specialists suddenly enjoy two robust tailwinds.
First, Iran has cyberattack capabilities that could pose tremendous problems for western businesses should retaliation occur in the digital ecosystem. Second, Iranian forces have used drones to attack data centers in the Middle East, which showcases a clear strategy.
The goal is to make the war economically unsustainable for the U.S., which puts western businesses at great risk. As such, the greater need for digital security and stability could benefit DDOG stock.
The Smart Money is Gravitating Toward DDOG Stock
While the fundamentals offer an intriguing backdrop for Datadog stock, the optimism appears to be shared by those who matter; that is, the smart money. Notably, DDOG recently enjoyed strongly bullish options flow, which highlights options trades focusing only on big block transactions (likely placed by institutional investors).
On Thursday, net trade sentiment landed at roughly $1.8 million, with a large portion of this dollar volume attributed to debit-based calls. In other words, debit-based transactions require the underlying security to reach a certain threshold to be profitable, thus having stronger directional implications than credit-based strategies.
However, the biggest clue regarding emerging positive sentiments among smart money traders comes in the form of the volatility skew. By definition, the skew identifies implied volatility (IV) — or a stock’s potential range of motion — across the strike price spectrum of a given options chain. In other words, this screener showcases the surface-area distortion of volatility space, allowing retail traders to understand how sophisticated market participants are structuring their risk profile.
If we were to frame volatility skew as a security protocol, spikes in the curvature would reflect areas of vulnerability; more specifically, traders are willing to pay an extra premium to protect against the implied directional risk.
In the case of DDOG stock, the April 17 expiration date shows a relatively calm and flat skew for strikes near the spot price. Where the curvature starts to noticeably rise is toward the right-hand boundaries (that is, toward higher strikes). To use options-focused lexicon, the smart money is pricing for upside convexity. That’s a fancy way of saying traders are prioritizing upside profits over downside protection.
To be fair, the skew isn’t overwhelmingly bullish. However, given that there is a positive distortion toward upper strikes, traders appear to be more focused on winning the game rather than locking down into a defensive shell.
Going for an Aggressive Trade
Looking at the Expected Move calculator, DDOG stock is expected to land between $105.59 and $139.13. Based on the underlying formulation, this dispersion represents a 13.71% high-low spread from the spot price — and I’m going to take the upper side of this range. My reasoning largely centers on the volatility skew, which shows that the smart money is prioritizing upside convexity over downside risk mitigation.
Plus, there’s the matter of Datadog stock already incurring a sizable decline. With the fundamentals cynically shifting in a positive direction for the observability specialist, I’m interested in a capped-risk, capped-reward bull call spread.
Specifically, I’m thinking about going super-aggressive with the 135/140 bull call spread expiring April 17. This trade requires DDOG stock to rise through the $140 strike at expiration. If it does, the maximum profit would be $315, representing a payout of over 170%.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
More news from Barchart
