It's not the easiest name to have confidence in but online used-car retailer Carvana Co (NYSE:CVNA) might still be able to deliver the goods for bullish speculators. While economic conditions cloud the overall retail environment, the automotive market in particular might not be as weak as presumed. Plus, CVNA stock just flashed a rare quantitative signal that could entice risk-tolerant traders.
Of course, it's impossible to discuss the potential trajectory of Carvana stock without mentioning the economy. There's no question that worrying signs exist, such as consumers skimping on simple luxuries — such as eating out — and instead electing low-cost alternatives. As well, pressure from the Trump administration's tariffs and still-elevated inflation pose serious challenges.
Perhaps the biggest concern stems from results within the industry. Late last month, weaker retail sales and higher loan loss provisions hit CarMax Inc (NYSE:KMX), leading to an earnings and revenue miss for the second quarter. Subsequently, KMX stock took a serious hit and it's still struggling for traction, down more than 28% in the trailing month.
Still, a bright spot to consider is that CarMax's Extended Protection Plans generated $576 margin per retail unit, which roughly matched last year's second-quarter result. Here's the thing — in that period last year, revenue landed at $7.01 billion, representing a 3.3% positive surprise.
In other words, when people are buying vehicles, they're digging deep to pay for the extra protection. This behavioral trait may signal that the used-car industry may be stronger than advertised.
Speculating On An Unusual Pattern For CVNA Stock
Moving forward, investors have two ways of betting on CVNA stock. One is to place a long-side wager ahead of the underlying company's fiscal third quarter, which is scheduled for release on Oct. 29. Playing the what-will-happen-on-earnings-day game is always a crapshoot.
Judging from CarMax's extended warranty per-unit performance, I would again imagine that the used-car market is more resilient than what some of the scary headlines suggest. Still, it's always going to be risky casting judgment on what could be a very kinetic event.
The other approach is to use a vertical options spread to bet on a smaller movement in CVNA stock ahead of the earnings report. With the leverage that options provide, the small gains in the open market can convert to a sizable payout in the derivatives market.
For those who want to take the latter approach, CVNA stock just flashed an unusual quant signal. In the trailing 10 weeks, it printed a 6-4-D sequence: six up weeks (defined as the return between Monday's open and Friday's close), four down weeks, with an overall downward trajectory. This sequence stands out because you would normally expect an accumulation-leaning pattern to trend northward, not southward.
Why is this important? Very loosely, under Markovian theory, the probability distribution of the next state depends only on the current state. This concept has been studied extensively in finance, which effectively means that the volatility of the next session depends largely on how volatile conditions are in the current session.
It's my hypothesis, then, that the behavioral state of the last 10 weeks can be instructive in determining how the next 10 weeks may pan out.
Now, what's special about the 6-4-D sequence is its rarity. Going back to January 2019, this sequence only accounts for 4.19% of all 10-week patterns that have flashed on a rolling basis.
Even better, the median price associated with the sequence rises noticeably higher than the median price of all outcomes. That's an asymmetry that's potentially aligned in our favor.
Taking Carvana Options For A Quick Spin
Using the market intelligence above, arguably the most attractive idea is the 367.50/375 bull call spread expiring Oct. 24. This near-term transaction involves buying the $367.50 call and simultaneously selling the $375 call, for a net debit paid of $345 (the most that can be lost in the trade).
Should CVNA stock rise through the second-leg strike price ($375) at expiration, the maximum profit stands at $405, a payout of over 117%. Breakeven comes in at $370.95, which is about 3.4% above the time-of-writing price.
To be sure, it's an aggressive wager, with various options calculators warning that it's a low-probability spread. However, that's a calculation based on an assumed distribution as represented by the Black-Scholes-Merton model.
What I'm presenting is the actual distribution of CVNA stock when the last 10 weeks flash the 6-4-D sequence. Generally, CVNA tends to rise from this sequence, which makes Carvana a surprisingly contrarian opportunity.
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