No, it's not the world's prettiest inverse head and shoulders pattern, but the setup on DigitalOcean Holdings (DOCN) may be just enticing enough for a small dice roll. I still don't love the overall action in the market. I wouldn't blame traders for sitting on the sidelines and investors from slowly moving into positions or tightening stops. Inflation appears to be creeping up on us, so we should take notice. By creeping, I mean into our views on stocks and trading. In terms of real-world inflation, there's no creeping, inflation is an all-out flasher right now showing us all its goods.
DOCN is one I've been on the hunt for since the IPO fizzled. It's not my first mention here nor my first trade in the name. Back in March, I outlined my strategy of legging into the name with the $35 to $40 areas being my prime targets. Shares ultimately bottomed around $35.50 in May before quickly rebounding back above $40. The first quarter results caused that push to the lows, but the overall result was short-term capitulation for bulls.
Compared to peers, DOCN trades at a discount when focused on enterprise value to sales. Its annual run-rate revenue grew by 30% year-over-year with projections set to keep that number pretty steady between 25% to 30% while capex has been declining. Average revenue per client increased 20% and the net dollar retention rate landed at 107%, an increase of 600 basis points. Anything above 100% is a positive for me.
As for that inverse head and shoulders pattern, it targets a move to $55 this summer. That may be a tad on the aggressive side, but I could see a 5-handle in the future here. The stock is thin, so an option trader is more challenging. I'd stick to stock or go with a stock replacement type of approach on the option. With a strengthening Full Stochastics indicator and a MACD hitting near highs (bullish divergence), I'm willing to take a starter here.
One thing to consider is the stock has been higher for a week now, so it is extended. That's why I would only take a half-sized position this week. A pullback to the $43 area with a bounce off that area would be ideal. Anything below $41.50 completely kills the momentum and bullish setup. If options are your thing, then the July $40 calls are how I would play it. Anything in the $5.60 to $5.90 area works as an attractive stock replacement. My preference is to simply buy shares around $45. Since this is thinner and could run if it gets moving, I'd also avoid the idea of selling covered calls against the name. Let the upside have room to breathe.