Sure, It’s Boring But Kroger’s (KR) Unusual Options Activity May Signal a Rebound Opportunity
At first glance, the unusual options activity for Kroger (KR) doesn’t seem all that remarkable. On Friday, total options volume reached 10,428 contracts, which actually represented a 52.06% decline against the trailing one-month average. Making matters worse, over the trailing 30 calendar days, KR stock had slipped more than 2%, bringing its year-to-date performance at just a bit over 8%.
Admittedly, Kroger is a boring enterprise so people shouldn’t expect too much. But even with the grocery giant tacking on its 2.11% dividend yield, the total return is still off the performance of the S&P 500, which is up over 14% YTD. And with so many other sectors delivering blistering returns, KR stock has silently languished in the background.
If that wasn’t pessimistic enough, Barchart’s options flow screener — which focuses exclusively on big block transactions — didn’t exactly provide a comforting read. On Friday, net trade sentiment slipped to $35,100 below parity, thus favoring the bears. It’s still early in the month but on a cumulative level (assuming no early exercising), net trade sentiment would have slipped to $156,100 below parity.
Bottom line, investors aren’t feeling KR stock, which carries a 56% Sell rating, per the Barchart Technical Opinion indicator. Based on traditional methodologies, it’s difficult to disagree. In the past six months (at a time when hot innovators have been flying), KR lost 1.31%.
Needless to say, belief in the business has slowed to a crawl. For options traders, this may be the signal contrarians have been looking for.
While the options data currently doesn’t provide an encouraging read, the numbers represent a static truth. However, for bullish traders, they’re putting their faith in a dynamic “truth” — a truth symbolizing things hoped for, the evidence of things not (yet) seen.
One of these truths is that the market tends to respond more acutely to unusually volatile or kinetic sessions than what would be otherwise expected for normal or baseline conditions. Mathematically, this concept is known as the GARCH effect or Generalized Autoregressive Conditional Heteroskedasticity. Without getting into the weeds, the key finding is that volatility is not randomly scattered over time but instead clusters.
If you consider the underlying math, GARCH is inherently Markovian: today’s volatility depends partly on yesterday’s volatility and partly on yesterday’s shock (the size of the return itself). My contribution to this line of thinking is that an extended behavioral state can lever a statistically meaningful impact on how the forward state materializes relative to baseline expectations.
Again, without going too deep into the conceptualization process, my hypothesis is that the distinctive profile of the last 10 weeks may have a pronounced impact on the next 10 weeks. If there is an asymmetric gap between conditional probabilities versus baseline expectations, it could potentially be exploited.
For Kroger specifically, KR stock in the last 10 weeks has printed a 3-7-D sequence: three up weeks, seven down weeks, with an overall downward trajectory. Personally, I love such sequences because the extended bearishness (distribution-heavy profile) means conceptually that traders are adjusting their prior assumptions. So, the resultant environment is Bayesian in spirit.
Because of the recalculation of assumptions, many securities exhibit buy-the-dip sentiments when the 3-7-D — or other distribution-heavy sequences — flash, making them exciting prospects for debit-buying speculators. In the case of KR stock, there’s a high probability that over the next several weeks, not only will the equity rise but that the median price of conditional outcomes will typically land above the expected median associated with baseline conditions.
In baseball terms, it’s like swinging on a 3-1 count: it’s what you’re supposed to do when you see a pitch you like.
At the end of last week, market makers offered what I consider to be a fantastic deal. Under the 67.50/70.00 bull call spread expiring Nov. 21, if KR stock rises through the second-leg strike price ($70) at expiration, the maximum profit would land at $163, a payout of over 187%. What’s more, the breakeven is only $68.37.
From the mindset of market makers, KR stock would need to rise 3.12% just for the spread to not lose money. They’re willing to underwrite that risk because of the soft performance. Again, in the trailing month, KR lost more than 2%. So, the assumption is that tacking on an additional month would yield even worse performance.
However, as I alluded to earlier, excessive bearishness in KR stock historically leads to traders reevaluating their priors — and this reevaluation tends to favor the bulls. As such, I would propose that the November monthly 67.50/70 bull spread is favorably mispriced.
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
