Pro Traders are Quietly Positioning Bullish Options on United Parcel Service (UPS) Stock: Here’s the Evidence
By almost every measure, United Parcel Service (UPS) gives the appearance of a money pit. Pull up its Price Overview report and you’re immediately greeted with a warning from the Barchart Technical Opinion indicator: a glaring 100% Strong Sell rating. From a technical standpoint, it doesn’t get much worse than that.
What raises even more alarm, though, is that the performance in the charts doesn’t offer any apparent reason for optimism. In the trailing half-year period — a time frame when many securities have witnessed blistering upswings — UPS stock is down about 24%. Since the beginning of the year, the express carrier and package delivery company has given up almost 34% of value.
As if to compound the misery, the fundamentals are also poor. Sales volume has slipped while earnings on a per-share basis has stalled. If these factors didn’t cause consternation, the company’s return on invested capital has also trended negatively.
Even options traders seem less than enthused about UPS stock. On Friday, total options volume sat at 53,323 contracts, which was down 19.85% from the trailing one month average. To emphasize the point, options flow — which focuses exclusively on big block transactions — showed net trade sentiment at $47,200 above parity.
To be sure, this figure technically favors the bulls. However, it’s a small amount relative to the millions of net dollar value that were exchanging hands that day. As such, UPS stock doesn’t seem convincing — until one considers the cumulative picture.
For the month so far in September, the cumulative net trade sentiment sits at around $6.5 million below parity (favoring the bears). However, from Sept. 19 through Sept. 26, the cumulative net sentiment landed at over $1.16 million.
In other words, the alpha dogs appear to have quietly positioned themselves bullishly in the last few sessions. Even better, UPS stock could be due for a surprising turnaround, if only temporarily.
While having directional conviction may be useful in an options strategy, much more is required for consistent success. After all, these derivative products expire, forcing participants to utilize a particular methodology to determine the best course of action.
Primarily, retail traders approach the options market using model-driven frameworks. Typically, this process involves taking the current stock price and integrating influencing elements, such as implied volatility and time to expiration. These calculations are then plugged into a distribution curve, which assumes a lognormal random walk (i.e. Black-Scholes-Merton).
While this approach is mathematically elegant, it’s also a simulation. For example, the probability-of-profit calculation common in many options-focused platforms is really just the area under the distribution curve beyond the underlying option strategy’s breakeven price. However, this is an estimated probability based on the presupposition that the simulation is accurate.
Another approach — the one that I prefer — is empirical. Rather than assume probabilities based on a lognormal distribution, traders can map out market behaviors based on what has actually happened in the past. However, I go one step further: I assume that certain behavioral states express different probabilities than what you would expect from aggregate (baseline) odds.
But how does one know what the current behavioral state is? That’s where my sequencing logic comes into play. It’s my theory that the structure of the last ten weeks can give us a better idea of what to expect over the next ten weeks. This is a concept borrowed straight out of the work of Russian mathematician Andrey Markov.
In the trailing 10 weeks, UPS stock has printed a 4-6-D sequence: four up weeks, six down weeks, with an overall negative trajectory. Since January 2019, this particular sequence has materialized 62 times on a rolling basis. Notably, in the fifth week following the sequence, UPS finds itself above the anchor price (i.e. Friday’s close of $83.72) 37 out of 62 times or nearly 60%.
What’s more, the median price of outcomes associated with the 4-6-D sequence is around $86. Essentially, this means that at the Week 5 marker, half of the dataset was above $86 and half below. This area may then represent an ideal zone to “place” the breakeven threshold for a vertical spread, allowing the second leg to stretch out depending on personal risk tolerance.
Using the market intelligence above, it’s now much easier to formulate an options strategy. Basically, we can sort bull call spreads by breakeven price. From there, choosing a second leg comes down to balancing expected probabilities with risk tolerance.
In my opinion, the most aggressive but rational trade is the 84/88 bull spread expiring Oct. 31. This transaction involves buying the $84 call and simultaneously selling the $88 call, for a net debit paid of $182 (the most that can be lost in the trade).
Should UPS stock rise through the second-leg strike price ($88) at expiration, the maximum profit is $218, a payout of nearly 120%. Breakeven comes in at $85.82, 2.51% above Friday’s closing price. Right now, the profit probability of this trade comes out to 42%. However, since the breakeven roughly matches the median price of the 4-6-D sequence, the “actual” probability is closer to 50%.
By my estimate, you’re getting about eight percentage points of free odds — and the chance for a sizable payout.
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