Stock Option Traders Mull ‘Ultimate Reversal' Signal on Royal Gold (RGLD)

Business Insider

5 days ago

With the precious metals market humming in recent months, enterprises like Royal Gold (RGLD) have enjoyed a tremendous run. Right now, despite some hiccups, RGLD stock has gained more than 17% on a year-to-date basis. During the same period, the benchmark S&P 500 (SPX) index has moved up by just over 9%.
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Despite the good cheer, RGLD stock has hit the buffers in July, tanking more than 16% from ~$180 at the start of the month to ~$150 today. Questions about the gold miner's long-term viability are being raised by nervous investors and analysts alike.
Unfortunately, the volatility has arrived at an awkward juncture. On August 6, after the market close, Royal Gold — which specializes in the acquisition and management of precious metal streams, royalties, and related interests — will release its results for the second quarter. Expectations are elevated, with analysts looking for earnings per share of $1.70 on revenue of $217.83 million. In the year-ago quarter, reported EPS was $1.25 on sales of $174.1 million.
It's anybody's guess whether Royal Gold can deliver the goods. However, if you believe in quantitative analysis — the use of mathematical models, statistical tools, and data to evaluate stock — then RDGL stock should be on your radar.
Royal Gold might not be the flashiest name in the gold sector—most investors are more likely to gravitate toward Newmont Mining (NEM), and that's understandable. But here's the catch: Newmont isn't showing what I'd call a textbook 'ultimate' reversal signal. Royal Gold (RGLD) is. That's why I'm Bullish on the stock—and why I'm about to walk you through an options strategy that could unlock significant short-term value.
The Background Behind Probabilistic RGLD Strategies
Before we get into this ultimate reversal signal, we have to lay out some ground rules. Scientifically, the foundation that I use to assess securities would fall under what's known as 'discrete-state probabilistic market modeling.' The latter phrasing is self-explanatory. However, a discrete state is where the confusion may set in for those unaccustomed to this methodology.
In other words, the price of RGLD stock is a continuous scalar signal. This means that the share price is unbounded in the positive direction. Most significantly, there is no objective standard by which people can label the share price as a 'good price.' By this logic, then, financial metrics are also scalar and thereby suffer from the labeling problem as well; that is, there is no standard for what a 'bad earnings' report is.
Similarly, in physics, there is no objective standard for what 'fast' means. It's a relative term. Regarding absolute truths (within a system), physicists talk about kinesis or no kinesis. That's measurable and falsifiable. Perhaps most important to our discussion, kinesis or no kinesis are both distinct, discrete states of motion.
Applying this logic to the stock market, I no longer view securities as an opaque framework by which I craft opinions such as a 'good opportunity' to buy. Having made this realization, it's clear to me that there is no first-order principle to define a 'good' opportunity.
Instead, I now think in terms of discrete states. This means that at the end of the day, the market is either a net buyer or a net seller. By categorizing price action not as scalar signals but as discrete sentiment voting records, we can map out the demand profile of our target security.
From there, we can formulate an empirical decision tree, making moves that statistically favor us and avoiding those that don't.
Getting Down to Business with Royal Gold
Moving from the theoretical to the practical: over the past 10 weeks, the market chose to buy RGLD stock two times and sell a whopping eight times. Throughout this period, the security incurred a downward trajectory. For brevity, we can label the sequence as 2-8-D.
Yes, it may sound strange to convert the price magnitude of RGLD stock to a simple binary code. However, we now have a distinct behavioral state that we can analyze. Through past analogs, we can determine how the market responds to the 2-8-D sequence relative to other sequences. Conducting this exercise across rolling 10-week intervals (since January 2019) gives us the following demand profile:
From the table above, the chance that a long position in RGLD stock will rise on any given week is only 50.73%. This is effectively our null hypothesis, the assumption of no mispricing. In contrast, I'm asserting an alternative hypothesis, that the flashing of the 2-8-D sequence has pushed the odds of long-side success over a one-week period to 71.43%.
Assuming the positive pathway, RGLD stock could rise 2.98%. Should the bulls maintain control of the market for the next three weeks, the expected median performance boost is an additional 1.64%. That means by August 22nd, RGLD could be priced close to $160.
In my opinion, this leaves us with two intriguing ideas. For the most aggressive trader, you may consider the 155/160 bull call spread expiring August 15th. This transaction involves buying the $155 call and simultaneously selling the $160 call, for a net debit paid of $190 (the maximum possible loss). Should RGLD stock rise through the short strike price of $160 at expiration, the maximum profit is $310, a payout of over 163%.
However, the above trade requires the bullish forecasted pathway to materialize sooner than projected. That's reasonable if you're wagering on Royal Gold delivering better-than-expected earnings figures next week. Of course, there is a high risk involved because the market can respond in unpredictable ways to financial disclosures.
Another approach is to consider the 155/165 bull spread expiring September 19th. This transaction requires a net debit of $395, with a max profit of $605, or a payout of over 153% if RGLD stock rises through the short strike price at expiration.
Much hinges on the statistical viability of the 2-8-D sequence. Running a one-tailed binomial test reveals a p-value of 0.0971, indicating a 9.71% chance that the implications of the sequence can materialize randomly rather than intentionally. This doesn't quite meet the threshold of statistical significance. However, I would argue that because of the stock market's open and highly entropic system, the implications are empirically intriguing.
Is Royal Gold (RGLD) a Buy, Sell, or Hold?
Turning to Wall Street, RGLD stock carries a Moderate Buy consensus rating based on three Buys, two Holds, and one Sell rating over the past three months. The average RGLD stock price target is $198.33, implying almost 30% upside potential over the coming year.
Heeding the Signal to Potential Profits in RGLD Stock
Although the recent volatility in Royal Gold represents a distraction heading into the company's Q2 earnings report, RGLD stock appears to be flashing what may be the ultimate reversal signal. Theoretically, there's now a higher-than-average chance that RGLD will break out of its funk, opening the door to speculation by bullish options traders.