Sure, an earnings beat is an earnings beat, but the top line — despite being a modest miss — represented a greater share of the story’s significance than what appeared to the naked eye. Without going into a factoid salad, the bottom line is that management practically admitted that it cannot grow its way toward a compelling business. Instead, it must cut costs to survive in a brutal, competitive environment.

However, there is a common argument that because BBY stock has been volatile, the security has likely priced in much of the bad news. Especially in the past six months, BBY has lost nearly 23% of value. As such, some contrarians view the big-box retailer as a reversion-to-the-mean play.

Recently, SimplyWall.St gave a breakdown of the bull and bear case for BBY stock, noting that the fair value of the security has been trimmed to $72.50 from $74.85. Of course, compared to Wednesday’s close of $63.53, the downwardly adjusted fair value of $72.50 is still more than 14% above the baseline. Using the article’s title as a reference, the implication is that BBY is a decent opportunity.

Nevertheless, I would be cautious about throwing around the fair value argument. Such a methodology assumes that behavioral regimes are static, whereas in reality they are more likely to be dynamic and path-dependent.

Look at baseball. A 25-year-old stud may have hit 40 jacks in a season. But a decade later, that same player is now older and fatter. He may also have picked up some injuries that are only compounding now. So, to say that you have a discounted cash flow to account for the myriad nuances of oldness, fatness, and injuries is quite a major presupposition.

Sure, the fair value of BBY stock could be accurate — or it might not be. A number just can’t be hand-waved into the discussion without a serious prosecution of how that number came to be.

Using an Inductive Approach to Trade BBY Stock

It must be stated upfront that I’m not against fair value analyses. However, you as the reader should realize that the validity of the value calculation is only as good as the model itself. Fundamentally, the challenge with this methodology is whether the patterns that have been observed in the past is truly a relevant benchmark for understanding the future.

Of course, this philosophical criticism applies to all inductive methodologies, which rely on the uniformity of nature; that is, the past is likely to repeat in the future. However, inductive forecasts have a tendency of falling apart when they don’t account for variable behavioral states. Therefore, I like to take a Markovian view of the market.

Let’s go back to our former stud turned the old-and-fat guy on the team. Just because a player is old and fat doesn’t necessarily mean that they don’t have any value. In fact, in certain situations, a veteran player who may have lost a step (or two) can bring exceptional value to the table. In other words, the probability of future performance depends on the current state — not the aggregate states of a distant past.

I believe BBY stock is in a similar situation. No, I don’t think it’s reasonable to assign a forward fair value of Best Buy based on an aggregate of past-paradigm valuation ratios. While these stats shouldn’t be ignored, we would be mixing together an environment where brick-and-mortars had dominance, along with the current era, where digital sales rule.

Instead, I prefer to look at how Best Buy stock traded based on behavioral states. Over the past few years, BBY has flashed all kinds of distinct market signals. Thus, it’s much more instructive to identify what the current market signal is and then look to the past as to how that specific signal operated relative to the aggregate baseline.

If there’s a positive variance between the signal and the aggregate noise — which I’d like to demonstrate that there is — we may have ourselves an opportunity.

Identifying a Compelling Trade for Best Buy Stock

Using a dataset going back to January 2019, a random 10-week long position held in Best Buy stock will likely land in a narrow range between $63 and $64 (assuming a starting price of $63.53). Peak probability density would land somewhere around $63.42. As it turns out, out of 362 rolling 10-week sequences, only 179 ended up above the aforementioned spot.

Put differently, BBY stock has an exceedance ratio of only 49.4%. Sure, some folks may buy BBY for its 6.04% dividend yield but from a near-term snapshot, there’s a statistically higher tendency of negative returns (strictly looking at capital gains) than positive.

Because of this bearish bias, we wouldn’t put the old and fat Best Buy in the lineup every day if we had better options. However, what we do know from the data is that BBY’s negative bias appears in the aggregate; it doesn’t always appear in all market sequences.

For example, in the past 10 weeks, BBY stock has printed only three up weeks, leading to an overall downward slope. Under this 3-7-D condition, the exceedance ratio at the end of a 10-week period on average rises to 58.1%. It’s an extremely small sample size so I don’t want to get too excited. Still, under Markovian logic, the forward probabilities of BBY do have a tendency of changing depending on the current state.

What’s more, the forward 10-week distribution is noticeably more optimistic, with Best Buy stock expected to land between $60 and $71. Further, peak probability density lands at around $66.50.

Thanks to this analysis, I’m tempted by the 65/70 bull call spread expiring June 18. Should BBY stock rise through the $70 strike at expiration, the maximum payout is over 138%. Breakeven lands at what the data perceives to be a realistic target at $67.10.

So, it’s not just a matter of delivering the goods; Best Buy also has to keep pace with other companies desperate for relevance. It’s looking to be a feisty earnings season for retail, which has caused some unusual rumblings in the options market.

Before heading into that bit, let’s quickly recap what Best Buy is expected to post up in terms of headline stats. For the Q4 disclosure — scheduled for Tuesday before the opening bell — analysts anticipate that the big-box retailer will post earnings per share of $2.47 on revenue of $13.91 billion. In the year-ago quarter, Best Buy managed to print EPS of $2.58 on revenue of $13.95 billion, beating the consensus targets of $2.40 and $13.66 billion, respectively.

Unfortunately, the performance of BBY stock has not been cooperative, losing roughly 29% in the past 52 weeks. Still, what makes BBY intriguing to some speculators is the non-ergodic nature of its return profile. Basically, the security sees pockets of directional biases which bold options traders could potentially exploit — and that’s the goal we’re trying to achieve here.

Volatility Skew as Vital Intel on BBY Stock

As I’ve mentioned in prior articles for StockEarnings.com, one of the most important pieces of first-order (observational) data that’s freely available to retail traders is volatility skew. Definitionally, the skew is a screener that identifies implied volatility (IV) — or a stock’s potential range of motion — across the strike price spectrum of a given options chain.

In simple language, the skew is a visual representation of surface-area distortion of volatility space, which allows retail traders to understand how the smart money is positioned for risk. Think of this tool like the starting formation of a soccer team. By analyzing the formation, you understand the coaching philosophy of the team you’re facing, such as being offense-minded or defensive.

In the case of Best Buy stock, the skew for the March 6 weekly options chain (the closest one following the retailer’s Q4 disclosure) is strongly hedged on both ends of the strike price boundaries. I’d characterize this setup as a 5-3-2 formation in soccer, with the skew featuring hedging activities to both guard against big drops in price while also positioning for upside convexity.

Put simply, the smart money doesn’t seem to have much directional conviction here, which makes BBY stock an enticing opportunity for aggressive speculators. If you’re one of the folks that believe sophisticated market participants are generally more prescient than average traders, Best Buy’s derivative market signals aren’t giving much up.

To find a deeper answer, we need to use some math to narrow down the list of possible outcomes.

Establishing the Realistic Parameters of Best Buy Stock

One of the quickest ways to get a reference point for where an optionable security may head next is the Black-Scholes-derived expected move calculator. For the March 6 expiration date, the calculator estimates a dispersion between $56.16 and $67.34.

While this range does seem useful, it’s merely a presuppositional reference point. The core problem with Black-Scholes-based calculations is that the forecasted figures are only “true” relative to the framework. In other words, Black-Scholes is a static formula that never changes, irrespective of the context the target security finds itself in.

For example, whether BBY stock just ripped out a 50% gain over the past week or suffered a 35% loss, it doesn’t matter; you would still use the same Black-Scholes formula. But my contention is that a stock that just ripped massively will be statistically treated differently than one that suffered a catastrophic loss.

It’s really common sense. For a high-performance stock, the main concern is holding the bag. For a negative-performance stock, the main concern is injury from falling knives. But in Black-Scholes world, none of this context is figured into the formulation.

I find that to be absurd and that’s the reason why I depend on the Markov property.

Drilling into a Better Answer

Not only is Black-Scholes just a reference point but the whole “expected move” calculation is tactically rudderless. It basically amounts to a formula that declares that the target security can go up or it can go down. That’s not analysis; that’s tautology.

Going back to the Markov property, the principle asserts that the future state of a system depends solely on the current state. In other words, transitions from one state to another depend heavily on the present context. For example, if you’re holding onto a two-goal lead late in the game, you’ll probably have a better chance of winning than if you were behind by two goals.

In the equities market, I theorize that different market structures will have an influence on forward distributions. For example, using data from January 2019, I calculated that the average 10-week distribution for BBY stock would land the security between $61.50 and $62.40, with probability density peaking around $61.85. Basically, BBY suffers from a negative bias under aggregate conditions.

However, under 4-6-D conditions — that is, when BBY in the past 10 weeks prints only four up weeks and an overall downward slope — the distribution would be expected to shift positively. In this case, BBY would likely land between $60 and $68, with probability density peaking at around $63.

Now, with Q4 earnings just around the corner, my belief is that these momentum trends that could take several weeks to materialize may see a compressed revaluation. With that in mind, I’m tempted by the 63/65 bull call spread expiring March 6.

This wager requires a net debit of $91, which is the most that can be lost. Should Best Buy stock rise through the $65 strike at expiration, the maximum payout would be nearly 120%. Breakeven lands at $63.91, helping to improve the trade’s probabilistic credibility.