At first glance, Novo Nordisk (NVO) seems like a lost cause. Open up Barchart’s main Price Overview screen for NVO stock and you’re quickly greeted with a warning: this ticker suffers from an 88% Strong Sell rating, a consequence of losing 15.49% of value over the trailing month. On a year-to-date basis, the healthcare giant has suffered a loss of almost 25%.
Things don’t seem to be getting better, with recent sessions incurring annoying nibbles of red ink. But from a contrarian view, this dynamic might be loose evidence that the bears are finding it difficult to find new justifications to send NVO stock lower. As such, there might be a case for a reactive rebound.
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In fact, we know that the concept of a rebound in Novo Nordisk stock is a well-established one within the recent paradigm. In the last two months, NVO has printed 10 weekly candlesticks. What’s alarming is that the flow of orders within this period is sharply pessimistic. Only three of the candlesticks featured net positive price action, meaning that 70% of the defined unit-wise volume incurred drawdowns.
Fundamentally, that’s significant for two reasons. First, the sustained red ink changes the immediate perception of NVO stock. While Novo Nordisk certainly enjoys a powerful reputation as a pharmaceutical heavyweight, at this moment, it would appear to be a falling knife. Second, because of this changed perception, it will likely alter NVO’s probabilistic trajectory.
Think of it this way. If you were offered an old baseball bat for $10,000, would you buy it? Probably not. If you knew that the bat was signed by Babe Ruth, though, you’d be irrational not to buy it. The bat didn’t change — our perception of what it could be worth did.
It’s the same principle with Novo Nordisk stock. At $50, some might question its value. At $38, I believe the market will see a good reason to jump the price higher.
A Compelling Offer on the Table for NVO Stock
Thanks to the leverage of an options strategy called the vertical spread, we don’t need Novo Nordisk stock to hit $50 to enjoy a decent reward. By buying a call option and underwriting a call at a higher strike price (on the same expiration date), we can reduce our cost outlay at the expense of limiting the upside potential.
Specifically, I’m looking at the 40/42.50 bull call spread expiring Nov. 20. While there still might be a case for targeting the October monthly, the extra time associated with the November options chain allows for some relative peace of mind.
Mechanically, speculators will be paying a net debit of $75 in the hopes that NVO stock will rise and trigger the $42.50 strike on expiration. If it does, the maximum profit would be $175, a payout of over 233%. That’s positively asymmetric in your favor because you would be getting back way more than what you put in — assuming of course that everything goes according to plan.
This is where things get tricky, as Wall Street’s options pricing mechanism pegs the probability of profit (breakeven) at only 33.2% at $40.75 on Nov. 20. A reverse-engineering of Barchart’s Expected Move calculator reveals that the probability of full profitability at $42.50 is about 22.3%.
Frankly, those are not compelling odds, which would likely cause financial experts to avoid talking about this trade for fear of negative expectancy. At the same time, it may be worthwhile to consider what the probabilities are saying before we make a final decision.
As a major pharmaceutical player, I don’t find it at all unreasonable that there are cases where the price discovery process of NVO stock may resemble a random walk. If so, the mathematical construction of these probabilities — derived from geometric Brownian motion — is defensible and credible.
However, I’m not entirely convinced that NVO stock will undergo a random walk from now until the expiration date.
Changed Perceptions Should Lead to Changed Probabilities for Novo Nordisk Stock
Right now, I think we can all agree that NVO stock is not structured in a bullish nor a neutral state. Instead, as I mentioned earlier, three out of the last 10 weekly candlesticks were positive. That’s a deeply bearish state if we were to consider the last 10 weeks as a single state.
So, the question now is, given that we are currently in an extremely bearish state, what are the chances of transitioning to a different state? We know through historical data that the typical response over the next 10 weeks following the aforementioned bearish state is a median price of around $41.80. We also know that over the next five to eight weeks, there tends to be a pronounced upside curvature in the NVO stock price.
Subsequently, I’m calculating a probability of full profitability between 48% and 52% of hitting $42.50 on or near the Nov. 20 expiration date. If so, the previously mentioned bull spread’s expected payoff would exceed its cost, making it potentially underpriced.
Bear in mind that I’m not claiming an alternative truth. Forecasts of the unknown future are necessarily presuppositional and my framework is no different. What I am presupposing, though, is that the current state of Novo Nordisk stock lends itself to a nonrandom response.
As a result, I want to utilize a dynamic analysis to better capture this anticipated nonrandom behavior. If you find this reasoning credible, you’ll want to keep a close eye on NVO stock.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
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