Red-Hot Kratos Defense Stock Attracts Option Bulls

Andrea Kramer

The shares of Kratos Defense & Security Solutions, Inc (NASDAQ:KTOS) are assailing new heights today, after the firm inked a $4.9 million contract to develop a THREAT system for the U.S. Army. While most of the stock market stumbled recently on the escalating U.S.-China trade war, KTOS stock has been on absolute fire, pacing for a sixth straight daily gain and its best month in two years. What's more, Kratos options traders are expecting more upside, with calls flying off the shelves today.

KTOS shares have already soared nearly 28% so far in May, set for their biggest monthly gain since May 2017. At last check, the stock is up 4.6% to trade at $20.33, and earlier soared as high as $20.53 -- territory not charted since 2008. From an even longer-term perspective, the security has rallied 81% in the past year, with pullbacks contained by its 200-day moving average.

KTOS stock chart may 15
KTOS stock chart may 15

Heading into today, Kratos stock was already well into overbought territory. Its 14-day Relative Strength Index (RSI) stood at a whopping 84 (a reading of 70 or higher is considered overbought). Still, options traders are expecting even higher highs.

Kratos Defense has seen roughly 17,000 call options change hands today -- 16 times its average intraday call volume. For comparison, fewer than 700 KTOS puts have traded so far. The June 20 call has attracted the most volume, accounting for more than 10,000 contracts, and it looks like speculators are buying the options to open. By purchasing the calls, the buyers expect KTOS shares to extend their run north of $20 before the options expire on Friday, June 21.

This affinity for bullish bets merely echoes the growing trend seen on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX), where traders have bought to open nearly six calls for every put in the past two weeks. However, some of the recent call buying -- particularly at out-of-the-money strikes -- could be attributable to shorts seeking some options insurance against an extended rally.

Short interest accounts for nearly 10% of the equity's total available float, and would take more than two weeks to buy back, at KTOS' average pace of trading. That's plenty of fuel for a short squeeze to boost the stock even higher.

Whatever the motive, now was a good time to purchase near-term KTOS options. The equity's Schaeffer's Volatility Index (SVI) of 34% stands in just the 9th percentile of its annual range, indicating that short-term options were pricing in relatively low volatility expectations for the shares.

According to Schaeffer's Senior Quantitative Analyst Rocky White, there have been five other times since 2008 wherein Kratos shares were within 2% of an annual high while simultaneously sporting an SVI in the bottom 20% of its annual range. After those signals, KTOS went on to average a one-month gain of 4.13%.