Taking the Under on DraftKings

According to a recent survey, three-quarters of American adults miss driving the most during the COVID-19 lockdown. Perhaps what they really miss is the freedom of choice when they get behind the wheel. Shall I head to the grocery store to pick up some groceries, or swing by the golf course to hit a bucket of balls?

However, based on the recent performance of online sports gambling emporium DraftKings (NSDQ: DKNG), it appears what they really miss is driving to a casino. After bottoming out below $11 on March 23, DKNG soared above $44 on June 2 for a gain of 300% in just 10 weeks!

Actually, it’s a bit more complicated than that. The company completed a reverse merger with a SPAC (special purpose acquisition company) in April and changed its name to DraftKings. But now that the legal maneuvering is over with, investors can gamble on which direction the dice will roll next for DraftKings.

In the near term, DraftKings can be viewed as a play on gambling in states like New Jersey. Gambling online is legal in New Jersey, including blackjack and roulette. In May, online gambling more than doubled in New Jersey, generating nearly $86 million of tax revenue to the state’s coffers.

Long Odds

DraftKings’ surging popularity is surprising given the paucity of sports to bet on at the moment. All of the major professional sports leagues are in limbo:

  • The NBA won’t begin its truncated playoff series until mid-August.
  • Major League Baseball has not yet come to an agreement with its players regarding how many games will be played and players’ salaries.
  • The NFL is moving forward under the assumption it will play a full schedule this year, but those plans could change quickly if there is a resurgence of COVID-19 in the fall.

I love sports, but I have a bad feeling about DraftKings. It’s not that I think gamblers will stop betting on sports. Quite the contrary; I believe gamblers will bet more than ever on sports once the coronavirus pandemic has been tamed.

However, I’m not so sure that they will do most of that betting on DraftKings. As the major casinos in Las Vegas well know, gamblers are notoriously disloyal. If a competitor across the street offers them a few extra comps, they will walk.

In this case, the barrier to entry is relatively low. Obtaining an online gambling license is the biggest hurdle, but not for a casino with the right connections. There are a lot of casinos bleeding money at the moment. Some of them may feel compelled to add online gambling to their revenue streams to hedge against a second wave of the coronavirus pandemic later this year.

Short Stack

As a rule, I don’t like betting on a business to fail. That’s bad karma for someone who makes a living off the stock market.

That said, I feel DraftKings has become overvalued and likely to plunge after releasing its next set of quarterly results in August. If I am right about that, buying puts on DKNG could be a profitable trade.

At the start of this week, the put option expiring on August 21 at the $40 strike price could be bought for $7. If DKNG falls below $33 prior to expiration, this trade will be profitable.

I realize a decline of 20% in two months seems unlikely. But keep in mind, DKNG was trading below $33 less than a month ago so it moves fast.

At the moment, short interest in DKNG is extremely low, with only 3% of shares outstanding. If short interest rises above 5%, it’s likely that somebody on Wall Street thinks they know something, so keep an eye on that number.

As any experienced gambler can tell you, all lucky streaks come to an end sooner or later. DraftKings has been on a roll lately, but its luck is about to change. You can bet on it.

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