AppLovin Stock (APP) Selloff Offers High-Risk, High-Reward Options Trade

Disappointment remains an overriding theme for mobile technology specialist AppLovin (APP). Since early June, APP stock has declined by more than 22%, with Friday’s price action being particularly severe. Fundamentally, investors have been rushing for the exits when it became clear that the underlying enterprise would not be joining the S&P 500.

Inclusion in the S&P 500 is more than a badge of honor—it drives institutional buying as index funds rebalance. Many expected AppLovin (APP) to join the index, but when S&P Global opted not to make changes this quarter, the stock dropped about 8% on the news.

The stock has clawed back some of its losses since last week. Despite this disappointment, analyst Stone Fox Capital views the exclusion as a temporary hiccup and remains focused on AppLovin’s strong fundamentals, particularly the robust growth of its ad platform.

For options traders, this dip has created a potentially attractive setup. With implied volatility elevated and sentiment temporarily shaken, long debit strategies could be relatively inexpensive. I remain short-term bullish on APP as a contrarian high-risk, high-reward opportunity.

Understanding the Framework of the Problem

Although the fundamental and technical frameworks for APP stock are arguably bullish for contrarians, both methodologies lack specificity. While financial publications typically utilize probabilistic language, they often lack an empirical basis for their lexicon. However, the problem ultimately stems from the architecture of these standard methodologies.

In technical analysis, practitioners often discuss patterns such as head-and-shoulders, cups, and handles. Unfortunately, none of the patterns in the technical realm are falsifiable. As such, empirical peer review is practically impossible. Fundamental analysis (along with technical analysis) suffers from the so-called “non-stationarity dilemma” — a complex way of saying that the core measurement metric, such as share price or valuation ratios, changes temporally and contextually.

Due to non-stationarity, any probabilistic analyses are derivative in nature, calculating outcomes across the entire distribution of the underlying dataset. This is akin to calculating a baseball player’s batting average for the entire season. It’s a factoid, which is a nice piece of information, but it doesn’t tell you the batting average for the situation you’re in right now. In other words, looking at how batters perform over the past 5-10 games is a better indicator of how they will perform in the next match (as opposed to looking at the seasonal average.

To calculate insightful odds, one must utilize conditional probabilities, which calculate outcomes based on a specific subset of the data. This tells you the “probability of the now.” The catch, though, is that conditional probabilities require the dataset to speak a unified language.

To impose this unification or stationarity, a trader can convert past price data into market breadth — sequences of accumulative and distributive sessions. Unlike raw share prices, market breadth is binary because it’s really a representation of demand: it’s either happening or it’s not. As such, demand profiles can be categorized and quantified for the ultimate purpose of extracting empirical probabilities.

Diving into the Statistical Setup of APP Stock

With the introduction of the framework out of the way, APP stock in the past two months charted a “6-4-U” sequence: six up weeks, four down weeks, with a net positive trajectory across the 10-week period. Generally speaking, APP performs better when the balance of cumulative sessions outnumbers distributive sessions over 10-week intervals.

When the above sequence flashes, in 62.86% of cases, the following week’s price action results in upside, with a median return of 5.82%. On Friday, APP stock closed at $324.70. Since then, the stock has perked up and now trades around $335 per share.

Should the implications of the 6-4-U sequence materialize as projected, the security could reach $343.60 in short order, perhaps within a week or two. If the bulls maintain control of the market, APP could potentially breach $350 within three weeks.

What makes this setup so intriguing is that, as a baseline, the chance that APP stock will rise on any given week is only 51.6%. To extend the baseball analogy, the 6-4-U sequence presents a favorable matchup for bullish traders. It doesn’t guarantee a successful outcome, of course. However, if this were a ballgame, the manager would give the green light to swing the bat.

Arguably, the most aggressive multi-leg options strategy that still falls within the realm of rationality is the 340/345 bull call spread expiring July 11. This transaction involves buying the $340 call and simultaneously selling the $345 call, resulting in a net debit paid of $240 (the maximum loss on the trade). If APP stock rises through the short strike price (345) at expiration, the maximum reward is $260, a payout of over 108%.

Is AppLovin a Good Stock to Buy?

Turning to Wall Street, APP stock has a Strong Buy consensus rating based on 16 Buys, three Holds, and zero Sell ratings over the past three months. The average APP stock price target is $503.29, implying ~50% upside potential over the coming year.

See more APP analyst ratings

Using Contextual Math to Formulate a Bullish Strategy for APP Stock

While AppLovin has been trending sharply downward since its S&P 500 snub, the red ink could present a discounted opportunity for intrepid speculators. Using conditional probabilities after layering share price data into binary market breadth sequences, the trader can calculate higher-than-average long-side odds for APP stock. With this statistical edge, one can apply the leverage of a bull spread to potentially extract a large payout.