With Iran Tensions Heating Up Again, Chevron Stock Looks Enticing

After a pivotal peace deal between the U.S. and Iran, tensions spiked once again as President Donald Trump stated that the ceasefire agreement was “over.” While Trump also mentioned that the recent flareup in the conflict did not mean a return to full-scale war, the mixed messaging nevertheless sank the S&P 500. However, the circumstance would seem to be a cynical catalyst for Chevron (CVX) stock.

Initially, the fossil-fuel sector experienced a sizable jump in value as the Iran war led to the closure of the critical Strait of Hormuz. Subsequently, economies roiled under the inflationary pressure, with many experts fearing a global depression if the situation wasn’t addressed swiftly. Thanks to the prior peace deal, it seemed as if disaster would be averted.

Now, the matter is back toward an uncertain state. From past behaviors, it’s quite possible that the Trump administration will back down and soften the rhetoric. Of course, this is a fluid situation so it’s incredibly difficult to assess where we may go from here. Either way, CVX stock now seems to be an intriguing proposition.

While shares do suffer from a Weak Sell rating, this is also part of the charm. In the modern equities market, much of the near-term trading is algorithmic or rules-based in nature. Thus, over a given period, the balance of bullish or bearish pressures can influence the forward trajectory of a security relative to an aggregate baseline.

For example, CVX stock is down about 15% since the end of March. Rules-based trading by various hedge funds and institutional players, combined with the latest geopolitical event, could easily trigger a positive mean reversion.

Now, mean reversion isn’t a controversial point and I’m only taking the next natural step: what if we could measure the impact of mean reversion conditioned to a specific quantitative signal?

Proof of Concept for CVX Stock Comes from Petrobras

At the beginning of the month, I stated that the collapsing Petrobras (PBR) stock price could represent a discounted opportunity. Rather than a handwaved assertion of undervaluation, I specifically mentioned that the excess balance of bearish pressure over a given time period historically resulted in outperformance relative to the random baseline.

More importantly, based on the observed median trajectory of PBR stock conditioned to the aforementioned signal, I inferred that traders should consider the 16.50/17 bull call spread expiring July 17. On the day of publication, PBR closed at $15.99. At time of writing (the evening of July 8), the security closed at $17.24. Should Petrobras continue to trend at this level, the bull spread holders will be able to earn the maximum 178% payout.

To be clear, I’m not saying that one example settles the debate. What I am saying is that I use this balance-of-pressure argument consistently across the securities I cover for Barchart. Primarily, the reason is that, in the absence of an objective answer within a practically non-determinative system, the arguable inference to the best explanation suggests that algorithmic trading will likely respond differently depending on the balance of pressure.

As such, if we measure these distortions, we may better infer where CVX stock may head next — just as I inferred for Petrobras.

So, what’s the signal for Chevron stock? In the past 10 weeks, CVX has printed four up weeks, leading to an overall downward slope. Conditioned for this 4-6-D sequence — which has materialized 49 times on a rolling basis since January 2019 — CVX over the next 10 weeks is expected to range between $174 and $183 (assuming a starting price of $175.97), with probability density peaking at $178.

Why is this significant? Because if we were to buy CVX stock randomly, the expected distribution of outcomes over the next 10 weeks would be between $173.50 and $178, with probability density peaking at $176.40.

On average across the spectrum, you’re looking at about a 1% positive variance. Mix in the leverage of options and that 1% could help deliver a robust payout.

A Key Nuance for Chevron Stock

One important point to note is that the aforementioned distribution of outcomes is not necessarily orderly and linear. From an inductive perspective following the flashing of the 4-6-D sequence, Chevron stock is expected to hit a median price of $180 on week 6 before trimming earlier gains. Assuming that this logic pans out, the idea to consider is the 175/180 bull call spread expiring Aug. 21.

With an expenditure of $255 per spread, traders will be hoping for CVX stock to rise through the second-leg strike at expiration. That’s a realistic target given the previously mentioned inductive framework. Further, the breakeven price is $177.55, providing some margin of safety.

What’s fascinating, though, is that the market is assigning a probability of only 46.5% that CVX stock reaches the breakeven price at expiration. This calculation largely stems from the distance (in terms of standard deviations) the threshold is from the spot price, assuming a risk-neutral, log-normal distribution of outcomes.

However, I disagree that stocks always trade according to a log-normal framework, especially when the balance of pressure over the defined time period is bearish. In this case, I would expect a higher propensity toward positive mean reversion as algorithmic trading protocols interpret the downcycle as a relative discount.

Exactly what the “real” probability of profit is will be open to vigorous debate. What we do know is that the exceedance ratio (or the chance that CVX stock will rise above the starting price) on week 6 is 65.3%. If I had to guess, I’d assume the probability of CVX reaching $180 at expiration is around 54% to 56%.

That’s a sizable gap from 46.5%, which makes CVX an appealing speculative target. Obviously, there’s no guarantee that established patterns will hold true this time around. However, I would argue that in the absence of alternative inferences (and not just interpretations of data), Chevron stock is a worthwhile bullish idea.