Options Report: Drilling for Bullish Oil Service Sector Opportunities

Crude oil prices continue to draw strength from an improving economic outlook. On Thursday, the government reported that the U.S. economy expanded at a faster-than-expected rate of 3.5% in the third quarter, marking an unofficial end to the recession. Gross domestic product (GDP) grew at its quickest pace in two years. Crude futures responded by soaring more than 3%, within reach of another annual high. What's more, crude prices have more than doubled from their Dec. 24 low of $35.13 per barrel.

The oil services sector has wasted no time in capitalizing on this strength, with the Oil Service HOLDRS Trust (OIH: sentiment, chart, options) soaring more than 65% since the start of the year. What's more, OIH continues to rally along the support of its 10-week and 20-week moving averages. The trust is currently pulling back to key support near the 120 region, which is home to a 38.2% Fibonacci retracement of its July 2008 peak and its December 2008 low.

Despite this strength, the brokerage bunch has room for upgrades, as 46% of the ratings on oil service stocks are currently "buys," compared to 67% in July 2008, and 61% at the end of last year. Any upgrades from these analysts could lend additional support.

Rowan Companies (RDC)

Digging into the sector, we find several potential bullish candidates. One stock that has performed particularly well is Rowan Companies (RDC: sentiment, chart, options). According to Hoover's, RDC performs contract drilling of oil and gas wells. Its fleet consists of 22 jack-up rigs (mobile drilling platforms) and 32 land-drilling rigs. The company performs contract drilling primarily in the Middle East, Texas, the Gulf of Mexico, and in the North Sea. Rowan plans to maintain its competitive edge by beefing up its current fleet of equipment.

Technically speaking, the stock has been in a steep uptrend since the market bottom in March, rallying more than 137% from its low near $10.28 per share. The equity is currently up more than 53% so far in 2009, easily outperforming the SPX during the same period. What's more, RDC has ridden support at its 10-week and 20-week moving averages steadily higher since early March. The shares are now trading firmly above former resistance at the 24 level, and could use this region as a springboard for additional gains.

Despite the strong uptrend, options players are attempting to call a top for RDC. Specifically, the stock's Schaeffer's put/call open interest ratio (SOIR), which compares put open interest against call open interest among options that expire in less than three months, stands at 1.48. This elevated reading indicates that put open interest easily outpaces call open interest among near-term options. What's more, this ratio also rests at an annual peak, indicating that options traders have not been more bearish toward RDC at any other time during the prior 52 weeks.

That said, data from the International Securities Exchange (ISE) and the Chicago Board Options Exchange (CBOE) reveals that sentiment may be shifting toward this outperformer. RDC's 10-day ISE/CBOE call/put ratio of 2.51 means that calls have been bought to open more than twice as often as puts during the prior two weeks. Should sentiment continue to move toward the bullish end of the spectrum, it could bring more sideline money to bear on RDC.

Finally, Wall Street is also betting heavily against the equity. According to Zacks, RDC has garnered only three "buys," compared to 11 "holds" and five "sells." This configuration leaves the door open for potential upgrades that could help push the security even higher. To take advantage of a continued capitulation by the bears to RDC's uptrend, options players should consider the equity's January 2010 22.50 call.

Diamond Offshore Drilling Inc. (DO)

Another oil services company that looks promising is Diamond Offshore Drilling Inc. (DO: sentiment, chart, options). For the record, DO is a contract offshore oil and gas driller capable of reaching depths of up to 10,000 feet. The company has 30 semisubmersibles, 14 jack-up rigs, and one drillship. The company also provides project management and other drilling-related services.

Technically speaking, DO has pulled back sharply during the past week, and is now trading just shy of $100 per share after hitting a near-term peak of $108.78 in the prior week. However, the stock is still sitting on a year-to-date gain of more than 67%, easily surpassing the SPX's performance during this time frame. What's more, the shares have gained momentum since the March bottom, rallying more than 83%.

Throughout this rally, DO has enjoyed the solid support of its rising 10-week and 20-week moving averages. The shares are currently pulling back to key support at the former of these trendlines, marking a potentially advantageous point to enter a long position.

Investors remain defiantly bearish on DO, however. On the options front, the stock's SOIR of 0.93 ranks in the upper half of its annual range, hinting at a negative skew from the speculative investors. Meanwhile, short sellers are also betting heavily against the security. Following a 9% increase in the number of DO shorted shares, more than 9.8% of the stock's float has been sold short. A rebound from technical support could spook these bears into buying back their positions to limit losses, potentially creating a short-squeeze situation.

Finally, DO has garnered 10 "buys," 10 "holds," and one "sell" rating. While Wall Street appears conflicted in regard to the stock's prospects, there is still plenty of room for upgrades. Options traders looking to take advantage of DO's upside potential should consider the stock's January 2010 96.25 call.

Halliburton Company

One final consideration for a potential bullish play is Halliburton Company (HAL: sentiment, chart, options). HAL is one of the largest oilfield services companies in the world, according to Hoover's. The company serves the upstream oil and gas industry with a complete range of services, from the location of hydrocarbons to the production of oil and gas. Services include providing production optimization, drilling evaluation, fluid services, and oilfield drilling software and consulting.

From a technical perspective, HAL has rallied more than 66% since the start of 2009. Furthermore, the shares have bested the SPX by more than 19% on a relative-strength basis during the past 40 trading days. Currently, the stock is trending higher along support at its 10-week and 20-week moving averages, which have helped usher HAL higher since March. The stock is also consolidating its gains into potential round-number support at the 30 level.

With such strong price action, it is surprising that options traders are still betting against the security. For instance, HAL's SOIR sits at 1.12, as puts easily outnumber calls among near-term options. What's more, the equity's ISE/CBOE 10-day put/call volume ratio of 1.18 arrives higher than all but 5% of those taken in the past year.

On the other hand, short interest accounts for less than 3% of the stock's total float, limiting the effectiveness of any potential short-covering rally. Finally, only two of the 14 analysts following HAL rate the shares a "hold" or worse. More adventurous traders looking to benefit from a rise in HAL shares should consider the stock's January 2010 25 call.