Options Corner: QuantumScape's Meltdown Offers A Potential Bounce-Back Trade

While technology companies of all stripes could seemingly do no wrong for much of this year, the sector received a harsh reality check recently — and QuantumScape Corp (NYSE:QS) was one of the key victims. Although the solid-state battery developer potentially represents a critical cog in advanced mobility, investor sentiment suffered under a risk-off environment. As such, QS stock suffered badly since Halloween. Still, there could be an opportunity amid the red ink.

In a nutshell, QuantumScape offers a potential catalyst for electric vehicles and similar technologies. While EVs have gained prominence over the last few years, U.S. sales have started to stagnate. However, if the company is able to deliver solid-state battery technology — which promises higher energy densities at potentially lower costs — it could revolutionize the mobility industry.

Of course, the problem is that the above vision is a big “if.” So far, QuantumScape remains hampered by wide-ranging skepticism related to commercial scaling. Further, getting the final product to the finish line is far from guaranteed due to underlying financial risks.

Some of the skepticism has been mitigated with QuantumScape achieving significant milestones; hence, the dramatic rise in QS stock that began in late June of this year. However, the latest fallout seems to be more related to investor concerns about rich premiums tied to tech enterprises, especially unproven ones.

Both analysts and politicians have sounded the alarm about a bubble brewing in artificial intelligence. While QuantumScape isn’t an AI company per se, it benefits from ancillary sentiment associated with innovation.

Plus, QuantumScape aligns with a familiar playbook: a promising business that has yet to prove that it can scale. Such types have been among the hardest hit in the latest downpour.

QS Stock Flashes A Rare Signal For Bullish Speculators

Admittedly, the fallout in QS stock is hideous, with the security losing 26% in the trailing month. Since Halloween, it’s dipped almost 38%. However, because of the extreme volatility, market makers are really skeptical about QuantumScape’s prospects. As such, they’re willing to offer relatively high payouts for not much movement in the stock. We can use this information to our advantage.

In order to leverage this dynamic, we have to understand the tendencies of QS stock. In my estimation, such assessments cannot be observed with the naked eye as QS travels as a singular journey across time. Instead, we must break apart the security as individual trials across a defined interval. By comparing the probability densities of these trials, we can better understand where the target stock is likely to cluster.

Using a Kolmogorov-Markov framework layered with kernel density estimations (KM-KDE), we can arrange the forward 10-week median returns of QS stock as a distributional curve, with outcomes ranging between $9.90 and $11.90 (assuming an anchor price of $11.46). Further, price clustering would likely be predominant at $10.73.

The above assessment aggregates all trials since QuantumScape’s public market debut. However, QS stock is structured in an unusual 4-6-U formation; that is, in the trailing 10 weeks, QS printed four up weeks and six down weeks, but with an overall upward slope.

Under this condition, the expected range of outcomes expands to between $9.40 and $13.35. To put it bluntly, QS stock offers high risk and high reward. However, the most important takeaway is that prices tend to cluster around $11.70. As such, there’s a 9.04% positive variance between the expected outcome versus what is contextually realistic.

Essentially, the above variance is an informational arbitrage that we can utilize to trade QS stock.

Following The Distributional Curve

Based on the market intelligence above, the trade that arguably makes the most sense is the 11/12 bull call spread expiring Dec. 19. This trade involves two simultaneous transactions: buy the $11 call and sell the $12 call, for a net debit paid of $51 (the most that can be lost).

Should QS stock rise through the second-leg strike ($12) at expiration, the maximum profit would come out to $49, a payout of 96%. Breakeven comes in at $11.51, which is a very reasonable target considering the previously mentioned anchor price.

Granted, there are much more tempting bull spreads with a strike price of $13 or higher. However, you’ll notice that the distributional curve begins to fall exponentially after $12. This means that there’s less likelihood that QS stock will congregate at those higher levels. Instead, the clustering is densest between $11.50 and $12.

If you wondered why I use KDE in my analysis, this is your answer. Without KDE, we wouldn’t understand visually where QS stock is likely to congregate. Because we have this insight — that very few people have, by the way — we can make smarter and more informed trading decisions.

The opinions and views expressed in this content are those of the individual author and do not necessarily reflect the views of Benzinga. Benzinga is not responsible for the accuracy or reliability of any information provided herein. This content is for informational purposes only and should not be misconstrued as investment advice or a recommendation to buy or sell any security. Readers are asked not to rely on the opinions or information herein, and encouraged to do their own due diligence before making investing decisions.

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