The Saturday Spread: Leveraging Applied Game Theory to Find Probabilistically Attractive Trades

Yahoo

2 days ago

With the Trump administration poised to hike tariffs on Canadian goods to 35%, the equities market ended on a down note heading into the weekend. Still, if there is a positive to the political malaise, it's that certain publicly traded enterprises are now on discount. Of course, the question is, which ones?
To answer this inquiry, the financial publication industry typically likes to rehash corporate disclosures and old newspaper clippings. The problem, though, is that the market has already digested all publicly available information. Therefore, it stretches credibility to assume the existence of undiscovered opinions — especially of those involving major entities.
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To better decipher and discover untapped trading opportunities, it may be useful to approach the market under the framework of applied game theory — essentially, a process to act when the odds favor you and step away when they do not.
The above paradigm can be best explained by a thought experiment. Imagine that you flip a coin a hundred times every business day. What you flip on Monday would have no bearing on what you flip on Tuesday, precisely because coin tosses represent random events.
If the market were also random, the chance of upside on any given week would land around 50%. Further, you could study the probabilities of any interval in the past. Under a random system, the observed odds across these intervals would be statistically no greater than a coin toss.
But that's not what we observe. Instead, different demand structures lead to different forward responses. By converting the price action of all stocks into a unified language — market breadth or sequences of accumulative and distributive sessions — we can uncover statistically viable patterns. This way, we're letting math (not emotions) be our north star.
An energy enterprise focused on natural gas processing and transportation, Williams Companies (WMB) presents a statistically intriguing case. In the past two months, WMB stock printed a 4-6-D sequence: four up weeks, six down weeks, with a negative trajectory across the 10-week period. While this conversion of price action into market breadth pancakes WMB's magnitude dynamism into a simple binary code, the move also eliminates the white noise in the data.
Stock prices fall under the category of continuous scalar signals, effectively meaning that they're not bounded by anything. That makes share price — and trends based on it — a messy metric to analyze. By focusing on market breadth (which is a representation of demand), we can get down to the core question: was the market a net buyer or net seller of the security at hand?
By converting WMB stock into market breadth sequences, we can structure its demand profile into the following table (based on rolling 10-week sequences):
L10 Category
Up Probability
Baseline Probability
Median Return if Up
2-8-D
40.00%
53.82%
0.63%
3-7-D
54.17%
53.82%
1.64%
4-6-D
61.54%
53.82%
1.91%
4-6-U
75.00%
53.82%
1.73%
5-5-D
52.78%
53.82%
1.97%
5-5-U
47.46%
53.82%
2.71%
6-4-D
83.33%
53.82%
4.64%
6-4-U
52.46%
53.82%
2.36%
7-3-U
50.00%
53.82%
1.86%
8-2-U
22.22%
53.82%
1.08%
9-1-U
33.33%
53.82%
2.43%
Given that WMB is printing a 4-6-D sequence, there's a 61.54% chance that the following week's price action results in upside, with a median return of 1.91%. Assuming that the bulls maintain control of the market for a second week, the median expected performance is another 0.84% tacked on. That would put WMB stock a bit shy of the $60 mark.
Those who are aggressive may consider the 58/60 bull call spread expiring July 25. Using data from Barchart Premier, we can identify that this transaction features a breakeven price of $58.95, giving us an adequate cushion if WMB stock doesn't quite reach $60 at expiration.
One of the leading advanced biotechnology companies in the world, Regeneron Pharmaceuticals (REGN) is also statistically appealing. In the past two months, REGN stock has printed a 6-4-D sequence: six up weeks, four down weeks, an overall negative trajectory. It's a rare sequence, having only materialized 22 times since January 2019. Part of the rarity could come down to the negative trajectory despite the balance of accumulative sessions being greater than distributive.
Notably, in 63.64% of cases when the 6-4-D sequence flashes, the following week's price action results in upside, with a median return of 2.48%. Should the bulls maintain control of the market for the next three weeks, an additional performance boost of 2.15% may be expected.
L10 Category
Up Probability
Baseline Probability
Median Return if Up
2-8-D
50.00%
54.71%
0.57%
3-7-D
45.71%
54.71%
2.15%
4-6-D
45.95%
54.71%
3.28%
4-6-U
46.15%
54.71%
2.16%
5-5-D
56.82%
54.71%
2.77%
5-5-U
60.71%
54.71%
2.46%
6-4-D
63.64%
54.71%
2.48%
6-4-U
47.17%
54.71%
1.96%
7-3-D
80.00%
54.71%
2.48%
7-3-U
54.05%
54.71%
2.51%
8-2-U
61.54%
54.71%
2.33%
9-1-U
62.50%
54.71%
1.81%
10-0-U
66.67%
54.71%
1.50%
Ordinarily, REGN stock enjoys a strong upward bias. In any given week, the chance that a long position in REGN will be profitable is 54.84%. What the 6-4-D sequence does, in effect, is to provide almost 9 percentage points of 'free' odds in favor of the bullish speculator, thus incentivizing a debit-based options strategy.
Aggressive traders may consider the 575/590 bull spread expiring Aug. 15. This transaction requires a net debit of $860 with a maximum payout of 74.42%.
A fleet management and safety platform provider, Samsara (IOT) is one of the leaders in applied artificial intelligence. While a powerfully relevant enterprise, IOT stock didn't get much love this past week, losing over 4% in the trailing five sessions. On a year-to-date basis, IOT dropped more than 14% of value. Still, contrarian market participants may want to give Samsara another look.
In the past two months, IOT printed a 4-6-D sequence: four up weeks, six down weeks, negative trajectory. For Samsara, the sequence is a relatively rare one, having materialized only 23 times since January 2019. However, it appears statistically intriguing because, in 65.22% of cases, the following week's price action results in upside, with a median return of 6.21%.
L10 Category
Up Probability
Baseline Probability
Median Return if Up
2-8-D
50.00%
52.69%
5.32%
3-7-D
54.55%
52.69%
7.00%
4-6-D
63.64%
52.69%
6.37%
4-6-U
80.00%
52.69%
11.61%
5-5-D
61.54%
52.69%
6.37%
5-5-U
60.00%
52.69%
4.27%
6-4-D
45.45%
52.69%
7.11%
6-4-U
42.86%
52.69%
5.19%
7-3-U
57.89%
52.69%
6.08%
8-2-U
25.00%
52.69%
19.07%
Should the bulls maintain control for a second week, the implied median performance boost is an additional 3.75%. On Friday, IOT stock closed at $37.39, meaning that it could be on pace to exceed the $41 level.
Given the above market intelligence, aggressive traders may consider the 39/41 bull call spread expiring Aug. 15. This transaction requires a net debit of $90, with a maximum payout of over 122%.
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