From the top-down view, circumstances don’t look at all pleasant for Elevance Health (ELV), one of the largest U.S. health insurance providers. Unfortunately, a tricky regulatory environment, combined with a mixed financial performance, had investors rushing for the exits. Still, for those who can stomach extreme volatility, ELV stock presents a tempting comeback prospect, especially for options traders.
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Last week, Elevance disclosed its results for the second quarter to a rough reception. True, the company managed to generate revenue of $49.4 billion, representing a 14% increase against the year-ago period. However, the healthcare specialist also posted adjusted EPS of $8.84, falling short of analysts’ consensus target of $9.07.
What really seemed to affect sentiment, though, was management’s guidance downgrade. For the full year, Elevance now anticipates EPS to land at around $30, which is down sharply from the prior range of $34.15 to $34.85. As well, the new forecast fell short of Wall Street’s consensus view of $34.40. Subsequently, ELV stock dropped a stunning 18.66% following the disappointing disclosure.
Since this time last year, Elevance has lost 43% of its equity value, making it a somewhat unappealing proposition. However, the red ink could potentially represent a discount, making the name an intriguing candidate for a speculative options trade based on probabilistic analysis.
Finding Patterns of Intentionality in ELV Stock
Of course, it must be said that not all securities that hemorrhage red ink are discounts; otherwise, people would simply buy when the Street sells off. Instead, there is a sensible methodology to weed out the hopeless enterprises and focus on the most viable.
Arguably, most people turn to fundamental analysis to identify undervalued opportunities. The problem here is that many of these analyses beg the question, smuggling in the premise of undervaluation into the conclusion without actually substantiating it. Those who turn to technical analysis encounter a similar problem, albeit in a visual sense, such as assuming that unfalsifiable and interpretive patterns possess predictive power.
To decipher intentionality, we must have a way of defining sentiment. Here, the temptation is to consider metrics such as earnings or share price. However, these stats are scalar and continuous, meaning that they are unbounded. By logical deduction, unbounded signals cannot be defined in the scientific or mathematical sense (i.e., there is no objective standard to define a “good” price or “bad” earnings).
Nevertheless, what we can objectively determine is whether during a particular session the market was a net buyer or net seller of ELV stock. This statistic, also known as market breadth, is a fundamental principle: either demand exists for the security in question or it doesn’t.
If we were to convert the chaos of price discovery into market breadth or sequences of accumulative and distributive sessions, we would compress the messiness into what is effectively a financial Morse code. While this process may sound ridiculously juvenile, it opens the door to empirical pattern recognition — and the likelihood of transition from one state of existence to another.
Reading the Market’s Code for Elevance Health
If we were to convert the price action of ELV stock into market breadth across rolling 10-week intervals, we would see the following demand profile:
Over the trailing two months, ELV stock has been charting a 3-7-D sequence: three up weeks, followed by seven down weeks, with a negative trajectory across the 10-week period. Ordinarily, such a signal should worry investors as the balance of distributive sessions far outweighs accumulative. Instead, though, the 3-7-D historically tends to represent a sentiment reversal.
In 73.68% of cases, the following week’s price action results in upside, with a median return of 3%. If the implications of the aforementioned sequence materialize as expected, ELV stock could rise toward the $285 level, possibly within 1-2 weeks. However, given the rare implosion of the equity, it wouldn’t be surprising to see a much greater upside target.
What’s interesting here is that, if we were to assume no mispricing — that is, the null hypothesis — then the chance of upside for ELV stock on any random week would come out to 55.7%. Therefore, my alternative hypothesis is that there is a mispricing, that the odds of upside are substantially higher than the expected baseline.
To confirm the empirical significance of the 3-7-D sequence, we can run a one-tailed binomial test, which in this case returns a p-value of 0.0868. Colloquially, this translates to a 91.32% confidence level that the signal is “intentional” rather than a product of random chance.
To be fair, this doesn’t meet the scientific standard of statistical significance, which is typically set at 95%. However, I would argue that, due to the stock market’s open system and high entropy, a confidence level of 91.32% carries considerable weight to the analysis.
Those who want to take a limited risk shot may consider the 280/290 bull call spread expiring August 15th. This transaction involves buying the $280 call and simultaneously selling the $290 call, for a net debit of $480 (the maximum possible loss). Should ELV stock rise through the short strike price of $290 at expiration, the maximum reward is $520, a payout of over 108%.
Is Elevance Health Stock a Good Buy?
Turning to Wall Street, ELV stock carries a Strong Buy consensus rating based on 12 Buys, four Holds, and zero Sell ratings over the past three months. The average ELV stock price target is $375.93, implying ~31% upside potential over the coming year.
Using Applied Probability to Extract Alpha from ELV Stock
While Elevance Health tumbled badly due to disappointing financial disclosures, opportunistic traders could hop on the potential discount. Rather than merely buying ELV stock because of its red ink, the security has instead flashed a statistical signal that offers data-backed confidence. This doesn’t guarantee a successful outcome, but it helps narrow down intriguing strategies in the options market.