In essence, information is only truly transmitted when the person receiving the intelligence enjoys a change in subsequent thinking relative to prior beliefs. Within this transmission, there are two main categories: degenerates and non-degenerates.
Understandably, these terms have a loaded meaning in the financial ecosystem. However, from a mathematical and theoretical decision-making point of view, the distinction comes down to the quality of the information. Essentially, a degenerate decision rule is one that ignores state information and always produces the same action. Indeed, degenerate rules are rules in the formal sense but they are not informative.
In contrast, a non-degenerate rule requires structure, discrimination, calibration, or predictive power. This standard implies a reduction of measurable or objective uncertainty and, as such, excludes pure persuasion without a link to the truth.
For example, if you were hesitant to buy dummy shares of ABC Semiconductor and my analysis focused solely on the analysts liking the name, this might convince you to go ahead and buy ABC. However, the purchase decision would be based on a transmission of degenerate information. Instead of a substantive analysis, I would have purchased a social proof signal, a coordination cure, and/or a permissions structure.
Nothing analysts liked about ABC reflected new information about the state of the company’s future cash flows, neither a probability distribution over outcomes nor a conditional framework that narrowed the range of likely scenarios. Such protocols would be examples of non-degenerate information transmission, where uncertainty is reduced through empirical or objective mechanisms in a conditional context.
In this article, we’ll look at three potentially discounted stocks to buy by examining their top-notch underlying analyses. Next, we will perform a second-order analysis to identify potential probability zones from the original list of possibilities.
Amazon (AMZN) has not had a good start to the new year, with the stock losing 9% of its equity value. However, this performance does not seem to deter the smart money, at least when looking at volatility bias, one of the many filters available to Premier Bar Chart members. This tool represents one of the most important first-order analyzes because it shows the implied volatility (IV) across the entire spectrum of strike prices for a particular option chain.
For the March 20 expiration date, the volatility bias shows the IV call rising above the puts at both ends of the strike spectrum. This setup indicates that protection against upside volatility is the top priority. Indeed, the smart money believes that the cost of missing out on bullish expression is more damaging than failing to protect against bearish moves.
In other words, the market expects AMZN stock to perform poorly due in part to weak technical signals. As such, if more sales materialize, the magnitude would be much smaller than if an unexpected rally occurred. Smart money recognizes that it is worse to be caught sleeping on the upside, and therefore the bias reflects anticipated optimism.
For the date of March 20, the expected movement calculator calls for a spread between $194.94 and $225.71. While this is an eye-opening list of possibilities, as debit-side traders, we are incentivized to narrow this range as much as possible. That’s where the Markov property comes into play, which states that the future state of a system depends entirely on the current state.
Right now, the current context is that in the last 10 weeks, AMZN stock recorded only three weeks higher, leading to an overall downward slope. Using enumerative induction and Bayesian-inspired inference, we expect that under 3-7-D conditions the AMZN will range between $200 and $230, with a probability density peaking near $212. However, the density is likely to remain relatively high until $223, when a notable drop occurs.
Given the market information above, I like the 215/220 bullish call spread expires March 20.
Chewy (CHWY) is another name that’s off to a slow start, with CHWY stock losing more than 15% since the beginning of January. This situation is a little different than Amazon, especially considering the volatility bias. For the March 20 expiration date, the top priority among smart money traders is managing downside risk. At the same time, there is potentially an opportunity for contrarianism.
First, the skew shows that the put IV is generally higher than the buy IV, especially at the edges of the strike price limits. On the left side, out-of-the-money (OTM) puts reflect increased demand for tail risk insurance, while deep-in-the-money (ITM) puts involve a mechanical short position, possibly to protect long exposure to CHWY stock.
Still, what is interesting is the nuanced profile of the volatility bias. Call IV curves upward towards new OTM attacks, suggesting that the possibility of upside tail risk is non-trivial. As such, the stance is not fully protective against debuffs, which could be an important clue.
Looking at the expected move calculator, the Black-Scholes derived model projects a spread between $24.88 and $31.16 for the March 20 expiration date. Again, this is a range of possibilities rather than a list of probabilities. To reduce the list, we must resort to a second-order Markov analysis.
Right now, the quantitative context is that CHWY stock is also structured in a 3-7-D formation. Under this signal, we can expect CHWY to fluctuate between $25 and $39 over the next 10 weeks, with the probability density peaking near $32.
Based on the above information, I am very tempted by the Bullish Call Spread 30/32.50 expires March 20.
Finally, Expedia Group (EXPE) completes our list of beaten stocks that could make a comeback. Currently, EXPE stock is tagged as Weak Buy based on the Technical Opinion indicator on the bar chart. However, it doesn’t really look like an opportunity, especially with EXPE down more than 16% so far this year. Still, a look at the volatility bias reveals an intriguing setup.
Overall, looking at the broader curvature for the March 20 expiration date, the priority among sophisticated market participants appears to be protection against downside volatility. In particular, the put IV is noticeably elevated above the call IV at the lower limits of the strike price. This dynamic suggests that the smart money is primarily concerned with insuring against tail risk.
But at the other end of the spectrum, call IV rises above put IV, which tells us that there is a perceived non-trivial risk that EXPE stock could shoot higher. In other words, while there is a clear incentive to protect against the bottom falling, there is simultaneously a demand for bullish expression, just in case.
Looking at the expected move calculator, the Black-Scholes derived model projects a range between $207.55 and $266.15 for the March 20 options chain, representing a sizeable high-low spread of 12.37% relative to the current spot price. Again, while we have a list of possibilities, we are trying to narrow it down to probabilities.
Currently, the quantitative context is that EXPE stock has printed a 4-6-D sequence. Under this condition, we would expect the stock to range between $220 and $290 over the next 10 weeks, with the probability density peaking around $262.
Given the above information, the 250/260 bullish spread expiring on March 20 could be attractive to speculative traders.
On the date of publication, Josh Enomoto had no (directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article are for informational purposes only. This article was originally published on Barchart.com
