As I write this Thursday, minutes before the markets open, today’s action will be slightly brighter than yesterday. The Dow lost 1,100 points (2.7%), its 10th consecutive down day, the worst streak for the index since the 1970s.
Whatever today brings, I couldn’t help but notice Dynatrace (DT) had two unusually active options in yesterday’s trading. The software provider for application performance management has not had a good year in the markets. Its shares are up just 1.4%, considerably less than the 28% gain for the Nasdaq 100.
While I don’t know much about the software company, it’s hard to miss that yesterday’s two options scream strangle. The only question is whether it’s a short or long strangle.
I’ll consider both strategies.
It’s a Long Strangle
For those unfamiliar with the long strangle, it is when you buy an OTM (out-of-the-money) call and put options that expire on the same day. The strike price is lower than the call strike.
You’re expecting a big move up or down that sends the share price above or below your breakeven. In the case of Dynatrace’s unusual options activity from yesterday, the breakeven on the upside (see below) is $61.45 and $51.05 on the downside.
You’re betting that the share price will be above $61.45 or below $51.05 at expiration.
Why this bet?
Let’s assume that the stock jumps to $70 by Jan. 17. Your profit would be $8.55 a share, or $855 [$70.00 (share price) - $60.00 (strike price) - $1.45 (ask price of both options)]. Now, if it falls to $42.50, you also make $8.55 a share [$52.50 (strike price) - $42.50 (share price) - $1.45 (ask price of both options)].
If the share price is between $51.05 and $61.45 at expiration, you’re out $1.45, or $145. It’s a very reasonable bet with a 30.9% profit probability.
It’s a Short Strangle
A short strangle is when you sell an OTM (out-of-the-money) call and put options that expire on the same day. The strike price is lower than the call strike.
Unlike the big move expected in a long strangle, you’re expecting the share price to move very little, staying within the upside and downside breakeven dollar values. In this case, it’s $61.20 on the upside and $51.30 on the downside.
If it does, you would make $1.20 a share, or $120, the bid price or premium income from both options, called Net Credit. The loss is unlimited.
So, if the share price goes to $70 at expiration, you’ll have to sell the DT stock at $60, putting your loss at $8.80, or $880 [$60.00 (strike price) - $70.00 (share price) + $1.20 (bid price of both options)]. Now, if it falls to $42.50, you’re out $8.80 a share [$42.50 (share price) - $52.50 (strike price) + $1.20 (bid price of both options)].
Although the potential loss of the short strangle is 6x higher than the long strangle in my examples, the profit probability is higher at 52.7%.
Which Is the Better Play?
Unless you're confident that the share price will remain between the upside and the downside breakeven, a rookie options trader would have difficulty tolerating the unlimited downside risk that the short strangle presents.
If you’re bullish about Dynatrace--analysts sure are, with 24 out of 32 rating it a Buy (4.47 out of 5) and a $61.59 target price--I’d be much more inclined to go with the long strangle because your maximum loss is reasonable at $145, while your upside is unlimited.
I’m not a technical analyst, but the chart since its August 2019 IPO at $16 suggests its stock has been on a slow roll higher since mid-2022. Given the strength of its business, I would not be shocked--it’s expected to grow earnings by 36% in fiscal 2025 (March year-end) and 19% in 2026--that it hit its all-time high of $80.13 in 2025.
According to S&P Global Market Intelligence, the analyst free cash flow estimate for 2025 is $399.10 million. It’s expected to grow to $972.9 million in 2029, a compound annual growth rate of 25%. At the same time, its gross margin is high at nearly 85% and is expected to stay that high over the next four years.
Its balance sheet is rock-solid, with just $81 million in total debt and $1.0 billion in cash and short-term investments.
I haven’t spent a lot of time on Dynatrace. I probably should. It’s a winner.
