1 Options Trade to Make Now to Bet on ON Semiconductor Stock Bouncing Back

By no means is ON Semiconductor (ON) an easy trade to navigate. Investors are increasingly skeptical about execution risks, particularly tied to how the tech company can fully integrate its $7 billion all-stock deal to buy edge-AI and connectivity chipmaker Synaptics (SYNA). At the same time, the strategic decision should help the firm gain additional ground in the competitive AI space, thus raising an interesting question for ON stock.

Basically, there’s a compelling quantitative case that the ticker could be a discount, at least in the near term. It’s not a matter of opinion but rather inductive logic. Previously, when ON stock suffered similar bearish cycles, the share price popped higher — perhaps due to dead-cat bounce mechanics — before settling into a consolidatory range.

Now, the evidence doesn’t really point to ON stock being a decisive, long-term discount. But for options traders with a short-term time horizon, ON has historically provided a scalping opportunity. If we assume that the same or similar pattern plays out over the next three weeks, the 83/90 bull call spread expiring Aug. 21 could be in play.

Why the Smart Money is Intrigued by ON Stock

Rest assured, the optimistic case for ON stock doesn’t just revolve around an empty opinion that the ticker could swing higher. Instead, the volatility skew for the upcoming Aug. 21 expiration date demonstrates the recognized possibility of upside.

To be fair, the volatility surface is structured as a “smile”, meaning that traders are hedging on both directions. For example, implied volatility (IV) — or the market’s anticipated movement — has reached a peak reading of 170.75% for far out-the-money (OTM) puts. This dynamic suggests that sophisticated market participants are protecting against a possible continuation of negativity.

Still, on the other end of the equation, far OTM call IV has reached a peak level of almost 150%. While the net bias appears to be favoring downside risk protection, it’s clear that — as of this moment — the smart money doesn’t want to be caught out if ON stock decides to skyrocket.

Of course, this setup can be interpreted as an ambiguous matter. However, a bullish trade in ON stock doesn’t necessarily mean that you’re going against the consensus of the smart money. Right now, top traders are simply unsure of ON’s future direction. Yet a quantitative signal may provide a key clue.

Order Flow Imbalance Could Lead to a Sharp Spike

Broadly speaking, what makes ON stock so attractive for contrarians is its order flow imbalance. In the last 10 weeks, only two of the sessions were positive, leading to a downward slope across the period. This 2-8-D quant signal is extremely rare, having only flashed nine times since January 2019. However, the beauty is that after this sequence materializes in the technical charts, ON tends to rebound temporarily.

Why would this rebound happen? More than likely, it’s a mechanical consequence of the modern equities market, which is dominated by rules-based algorithms. These automated trading systems may interpret the sharp, extended decline of an otherwise quality name like ON stock as a bargain. With the weak hands presumably shaken out, the big players jump in automatically, driving up the share price.

To be clear, it’s not a proven thesis. Still, there’s some convincing evidence to consider. When you buy ON stock randomly, the range of expected outcomes over the next 10 weeks is quite shallow, typically between $69.50 and $81.50. But under 2-8-D conditions, the expected forward 10-week distribution shifts northward to between $74 and $100.

As the data stands, though, the bulk of upside tends to occur within the next four weeks. I’m focused on the Aug. 21 expiration date because, in my opinion, adding another week of theta makes the underlying options spread more expensive.

Besides, with ON stock forecasted to rise through the $90 strike over the next three weeks, a near-term spread may be ideal.

Targeting a Specific Options Strategy

Based on the inductive analysis above, arguably an ideal options strategy is to consider the 83/90 bull call spread expiring Aug. 21, as mentioned earlier in the article. Should ON stock rise through the $90 strike at expiration, the maximum payout would clock in at 115.39%.

What’s most enticing from a mathematical perspective, though, is the spread’s breakeven price of $86.25. Using a continuous price pathway model (i.e. Black-Scholes), Wall Street assigns a probability of profit of only 35.1%. Because the max payout is only a little over 115%, this trade carries a negative expected value if it were conducted over a long period of time.

However, market returns under real conditions don’t always exhibit continuous pricing behavior; instead, the pathway is discontinuous. That’s where the term volatility cluster comes from. When public securities move, they don’t necessarily move according to a neat, linear lockstep protocol. Instead, assets often jump from one threshold to another, especially from a major event like an earnings disclosure.

What the data suggests for ON stock is that a temporary volatility cluster may occur due to the severe order flow imbalance. In fact, out of the nine times that the 2-8-D signal has flashed, ON has exceeded the equivalent of the $86.25 breakeven price a total of six times at the end of week 3 (Aug. 21). As such, the conditional probability of profit is roughly 67%.

Granted, we’re talking about an extremely small sample size so great caution needs to be exercised. Nevertheless, if you’re in the mood to speculate, ON stock makes a compelling case for itself.