Why Strategy’s (MSTR) Q2 Earnings Test May Help Engineer a Short-Term Pop

I’m going to say this straight out so that there’s no confusion: Strategy (MSTR) has not proven to be a viable investment. Plus, as long as the underlying cryptocurrency sector continues to underperform, MSTR stock would not be a candidate for a long-term hold. For those who are genuine risk-takers, though, a quantitative case can be made for the crypto proxy.

Basically, we’re going to play the order-flow balance game. If you look at the weekly candlestick chart for MSTR stock, you’ll notice that the security has only printed two positive candlesticks over the last 10 weeks, thus leading to a (sharp) downward slope across the period. Ordinarily, that would be interpreted as bad news, as Strategy’s 100% Strong Sell rating ignominiously indicates.

But here’s what’s interesting, though. Technical indicators, by their very nature, are rearward looking. So yes, MSTR stock suffering a loss of almost 21% in the trailing month qualifies Strategy as a hot mess. Nevertheless, because the modern equities market is dominated by algorithmic, rules-based trading, a strong possibility exists that these protocols will interpret MSTR as a relative discount.

While there might be some disagreement with the presupposition, here’s how I would defend the hypothesis. Currently, we are encountering a wild paradigm shift in terms of artificial intelligence. When things are clicking, no human can come close to the productivity of today’s autonomous machines.

Further, to an elite AI developer, it’s not that difficult to design trading algorithms. You’re building programs with the main purpose of identifying specific signals and generating transactions based on that data. So, as compromised as Strategy stock is, the underlying business is still relevant. It wouldn’t take much for the algos to jump on this opportunity for a quick contrarian trade.

Of course, for such transactions to be effective, you have to be first (or at least extremely quick); hence, the use of algos. That’s why we should spend more time on how the machines might react versus how humans might respond.

How Do We Figure Out What the Machines Think About MSTR Stock?

Obviously, nobody knows with certainty what any market participant is thinking. Still, the big dogs leave a structural footprint with their mass-scale behaviors. Indeed, a key reason why unusual options activity screeners are so popular is that you can see the high volume of transactions that are being recorded.

Now, it’s going to be incredibly difficult to litigate all the datapoints in an options screener, mostly because derivatives represent a zero-sum game and interpreting intent is not always possible. It also must be said that one of the risks of buying an unusual options trade is that you’re often incurring the trade at peak implied volatility (if you’re on the debit side).

However, when filtering past historical data for specific quantitative signals, it’s arguably inevitable that public securities leave structural footprints. In other words, under certain conditions, the expected distribution of future outcomes will change relative to a baseline aggregate.

Let’s look at MSTR stock. As I mentioned earlier, it just flashed a 2-8-D sequence: two up weeks, eight down weeks, downward slope. Conditioned for this signal, the expected forward 10-week distribution would be expected to land between $93 and $107 (assuming a starting price of $97.47), with peak probability density occurring at potentially $97.50.
If we were to trade Strategy stock randomly, the expected forward distribution would likely land between $96.50 and $99.50, with probability density peaking at $98. In terms of likely outcomes, the 2-8-D signal isn’t exactly great if you decide to hold for the full 10-week period.

However, the performance variance between the signal and the aggregate isn’t orderly and linear. Notably, in week 3 following the flashing of the signal, the median outcome is the equivalent of MSTR stock reaching $101.95.

Combined with the fact that Strategy is expected to release its critical second-quarter earnings report on July 30, there’s a chance that any legitimately encouraging news may help boost MSTR stock. After all, the ticker has been beaten down severely so it may be more primed for positive mean reversion.

Identifying a Potential Options Play

Although a plethora of options strategies exist for MSTR stock, I have my eye on the 100/104 bull call spread expiring July 31, just a day after earnings. As you might suspect, this idea banks on getting some love from the company’s results. I want to go with a thin spread to help reduce the net debit required (as this isn’t exactly the most high-confidence trade ever).

What’s interesting, though, is the breakeven price, which comes in at $101.95. Right now, Wall Street assigns a probability of profit (i.e. how likely Strategy stock is to reach break even at expiration) of only 40.5%. In terms of risk management, that’s not good. Since the maximum payout of the 100/104 bull spread is only 105.13%, you roughly win $200 if you’re right and lose $200 if you’re wrong.

The problem? With a 40.5% probability of profit, over time, you would statistically incur what’s known as negative expected value.

However, you as the retail trader are not forced to accept the Black-Scholes-derived probability as the sole arbiter of truth. In my analysis, the 2-8-D signal has flashed 16 times on a rolling basis since January 2019. Yes, we are talking about small sample sizes so take what I have to say next with a grain of salt. But in eight instances, MSTR stock exceeded the equivalent of $101.95 a total of eight times.

From an empirical, what-you-see-is-what-you-get standpoint, I’m looking at a 50% probability of profit. That’s almost 1,000 basis points of “free odds” in you favor (assuming the validity of the model).

No, we’re still not talking about a high-confidence trade. However, there’s a quantitative case here that this bull spread at least enjoys neutral expected value, not negative. That’s a big improvement, making Strategy stock an intriguing idea for speculators.