From multiple angles, Chinese e-commerce giant JD.com (JD) appears to be a suboptimal investment. From a broad perspective, geopolitical dynamics continue to rear their ugly head. For example, the World Economic Forum recently noted that U.S. companies have cut investments in the world’s second-largest economy to record lows due to tariffs and trade tensions.
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Down to the surface level, the Chinese consumer economy is struggling. Interestingly, Procter & Gamble (PG) recently posted fiscal fourth-quarter earnings results that beat on both the top and bottom lines. It was noted that while P&G took market share in China, overall demand in the country was down. With consumer spending decelerating for essential and everyday goods, this headwind may not bode well for JD stock.
Then, you must factor in market volatility. Heading into the weekend, JD stock declined by nearly 2%. Over the past week, the security plunged more than 7%. And since the start of the year, JD has shed almost 11%. It’s been an ugly ride so far this year, enough so that the company suffered several analyst downgrades.
Generally speaking, Wall Street experts tend to be diplomatic since they want robust relationships with the enterprises that they cover. For that reason, outright Sell ratings are rare, yet we saw one from Arete recently.
At this point, it may be tempting to give up on JD.com, especially with its own Q2 earnings coming up on August 14th. However, there’s a straightforward quantitative case to be made: contrarian investors willing to take a bullish stance could be positioned for significant upside.
Options Strategies Needn’t be Confusing
Trading strategies that utilize options are gaining in popularity, for obvious reasons. Risk can be precisely ringfenced, while returns can be open-ended. Essentially, options strategies and the math involved fall under two basic categories: prescriptive and descriptive. In simple terms, prescriptive frameworks focus on what should be; descriptive frameworks focus on what has been. A sports analogy is helpful to really bring home the difference.
Using Baseball to Understand Options
Imagine that you’re the manager of a Major League Baseball team and you’re down to your last out in the bottom of the ninth inning. If you put the player with the best career batting average at the plate, you’re taking a prescriptive approach. You’re saying that because this player is an all-around solid competitor, he should be able to perform well.
On the other hand, a descriptive approach would give the responsibility to the guy who may not have the highest average but consistently comes through in the clutch. You’ve seen that his stats pop under pressure, so you go with what you’ve observed conditionally.
For me (and I suspect most people), the descriptive approach is more intuitive. It’s how we naturally think as human beings. In contrast, I find the prescriptive approach to be misguided and opaque. Moreover, the approach is unnecessarily complicated. Prescription is where you get all the convoluted stochastic calculus that undergirds implied volatility and other esoteric metrics. Stated differently, descriptive financial modeling is easier and tends to be more effective when it comes to actual trading and investing.
Putting Theory into Practice with JD.com
To really make the descriptive approach work, we must convert the unbounded, continuous price data into bounded, exclusive discrete events. Scientifically, we don’t want to analyze the JD stock price but rather the market’s current sentiment.
Seeing as market noise is a large component of typical price action, there is no objective way to define any price as being a “good” or “bad” time to buy/sell. These are subjective observations. However, what we can say objectively is that, at the end of the session, the market is either a net buyer of JD or a net seller.
When looking at the previous ten weeks of JD’s price action, the market voted to buy JD stock three times and sell seven times, with the security incurring a downward trajectory. For brevity, we can label this sequence as 3-7-D. Now, through the study of past analogs, we can see how the market responds to this sequence flashing.
Even better, we can conduct this discretization process across rolling 10-week intervals extending back to the end of our dataset (which in this case is January 2019). This exercise gives us the following demand profile:
From the table above, we can see that the chance that a long position in JD stock will be profitable on any given week is only 49.85%, a negative bias. Essentially, this is our null hypothesis, the assumption of no mispricing. However, our alternative hypothesis is that, because of the 3-7-D sequence flashing, the probability of upside jumps to 60.71% — that’s a significant mispricing, and assuming the validity of the 3-7-D, it incentivizes a debit-based options strategy.
From our observations, we note that the median return following the 3-7-D flashing is 4.31%. That would potentially put JD stock on a course above $32. Subsequently, that would make the 31/32 bull call spread expiring September 19 incredibly tempting.
The above transaction involves buying the $31 call and simultaneously selling the $32 call, for a net debit paid of $45 (the maximum possible loss on the trade). Should JD stock rise through the short strike price of $32 at expiration, the maximum profit is $55, a payout of over 122%.
And that’s it — we’re simply using conditional probabilities to determine whether the hand favors us and betting big when it does. This is the crux of applied game theory.
Is JD.com Stock a Good Buy?
Turning to Wall Street, JD stock carries a Moderate Buy consensus rating based on 11 Buys, two Holds, and one Sell rating over the past three months. JD’s average stock price target is $43.29, implying 38% upside potential over the coming year.
JD.com Vulnerabilities Open the Door for Options Spec Trade
At first glance, JD.com appears weighed down by political and economic headwinds. However, the stock is now triggering a quantitative signal that suggests an above-average chance of a sentiment shift. By applying straightforward descriptive math—rather than complex prescriptive models—options traders can identify a potential setup for meaningful gains.