Suppose that you’re the manager of an MLB team and it’s the bottom of the ninth of the World Series. You’re down to your last out. Do you go with the player who has a great career batting average but can’t perform well under pressure or elect the guy who had a relatively average season but consistently comes through in the clutch?
If you’re into baseball or just sports in general, the answer is obvious: you go with the competitor that contextually gives you the best chance to win. Ultimately, your job is to take home championships, not dabble with math exercises.
However, what seems so obvious isn’t that way in the financial sector. Practically every western approach — from Black-Scholes-Merton-based models to the efficient market hypothesis — utilizes prescriptive financial modeling. Essentially, these methodologies dictate what should be, which theoretically sounds enticing. However, my contention is that this prescription is flawed.
In contrast, I prefer a Markovian approach, which models behavior based on a descriptive framework. Such methodologies demonstrate what has been, not what should be. As such, we don’t need complicated formulas rooted in stochastic calculus and other difficult concepts.
A key reason why I’m not a fan of prescriptive models like Black-Scholes (aside from its inapplicability with American options) is that the underlying probabilities are based on the entire distribution of the dataset. That’s like trying to predict hurricanes based on the last ten years’ worth of weather reports. Instead, to accomplish this, you would focus on the immediate conditions that cause hurricanes to be more likely.
With that said, below are three stocks that are potentially flashing buy signals based on a descriptive framework.
Quantitatively, Kroger (KR) makes for an intriguing idea for bullish speculators. In the past 10 weeks, the market has essentially voted to buy KR stock four times and sell six times. Throughout this period, KR enjoyed an upward bias. For brevity, we can abbreviate the sequence as 4-6-U.
At first glance, it may seem silly to compress the price magnitude of KR stock into a simple binary code. But what we have accomplished here is to define KR’s price discovery process as a behavioral state. Through the study of past analogs, we can determine how the market responds to the 4-6-U sequence relative to the baseline.
It’s just like card counting in blackjack. If the deck favors us, we bet big. If it doesn’t, we bet small (or in this case, not at all).
On any given week, the chance that a long position in KR stock will rise is only 51.74%. It’s an upward bias but a very modest one. However, this statistic stems from the derivative probability of upside across the entire distribution of the dataset. But our contention is that because the deck is flashing a 4-6-U sequence, the odds of upside are actually 72.73%.
Barchart Premier members gain full access to the platform’s options pricing tools, which can be incredibly powerful when integrated with a Markovian approach. Here, we can identify that the 72/73 bull call spread expiring Aug. 29 may be the least expensive multi-leg strategy that has a realistic chance of being fully profitable.
For extreme contrarians, Cinemark (CNK) may be an intriguing name for its implied discount. On Friday, CNK stock dropped nearly 4%, while for the trailing week, it hemorrhaged almost 11%. On a year-to-date basis, the security — which is tied to the struggling movie theater business model — is down 16.49%. It’s a mess but it has the potential to be meme-able.
In the past 10 weeks, the market voted to buy CNK stock four times and sell six times. Throughout this period, CNK incurred a downward trajectory. For brevity, we can label this sequence as 4-6-D. Through past analogs, we can identify that this sequence has materialized 46 times on a rolling basis since January 2019. In 58.7% of cases, the following week’s price action results in upside, with a median return of 3.87%.
As a baseline, the next-week upside probability is only 51.16%. Therefore, assuming that the implications of the 4-6-D hold up, there’s a compelling incentive to place a wager. With CNK stock closing at $25.87, it could swing close to $27 in short order.
It’s a terribly risky idea but for hardened speculators, the 26/27 bull call spread expiring Aug. 15 could be attractive.
It’s no exaggeration to say that Confluent (CFLT) got obliterated this past week. On Friday, CFLT stock dropped 3%, which would be notable in and of itself. However, the real drama occurred the day before. Following a second-quarter earnings print that left investors severely disappointed, CFLT opened sharply lower against Wednesday’s close. When the dust settled, the security had lost almost 38% in the trailing five sessions.
Generally, it’s best to avoid enterprises exhibiting such extreme volatility. However, the market has enticingly printed a relatively rare 6-4-D sequence. It’s unusual because, despite the number of accumulative sessions outweighing distributive, the overall trajectory is negative. This quantitative signal has flashed 23 times since the company’s public market debut in 2021. Notably, in 65.22% of cases, the following week’s price action results in upside, with a median return of 3.79%.
As a baseline, the chance that a long position in CFLT stock will rise is only 53.49%. Subsequently, there appears to be a clear incentive to place a wager. With CFLT closing at $17.20 on Friday, it could jump to $17.85, perhaps close to $18, in short order.
With that said, the most aggressive idea that you can arguably consider while still being rational is the 17/18 bull spread expiring Aug. 15.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com
