You don’t need to find many excuses to avoid Abbott Laboratories (NYSE:ABT). Despite its powerhouse label in the healthcare segment, ABT stock simply hasn’t lived up to the billing. Since the start of the year, the ticker is down more than 19%. Recent momentum lacks a convincing argument for a comeback, with the company suffering a roughly 9% drawdown in the trailing month.
Still, from a contrarian view, now may be the opportune time to consider a long position in ABT stock. After all, if you wait on the sidelines until after Abbott Labs proves itself, the very act of proving itself will almost certainly swing the valuation northward. At that point, the conversation may shift toward whether or not the healthcare giant deserves its rich premium.
Obviously, the key for speculative options traders is to bet that the wave will happen before it actually happens. You can’t wait for that confirmation because, for fear of being ridiculously tautological, confirmation undercuts the often-stratospheric risk-reward profile of speculation.
In the case of Abbott Labs stock, however, the underlying company has been making a fool out of market participants (including yours truly). Technically, it would appear that ABT can’t decide whether it’s going to decisively move higher or lower. Instead, we’re stuck in a see-sawing action that only serves to universally frustrate traders on both sides of the sentiment aisle.
Still, as someone focused on the data, options traders need to give ABT stock another look. Right now, the overwhelming consensus is that Abbott is locked in a bearish state. As such, this perception will likely alter the ticker’s probabilistic forward trajectory.
Understanding the Markov Chain Logic for ABT Stock
Let’s assume that each 10-week (rolling) sequence of Abbott Labs stock is a distinct behavioral state. Under this framework, we can easily label ABT as suffering a decisively bearish condition. That’s because out of the last 10 weekly candlesticks, only three of the sessions saw net positive price growth. That also means that within the defined period, 70% of the unit-wise volume incurred drawdowns.
Why is this significant? First, this prolonged bearish state changes the current perception of ABT stock. Yes, as a whole, Abbott Laboratories enjoys prominence as a healthcare leader. But right now, investors aren’t treating ABT as a leader — more like a laggard. Second, because of this changed perception, it will likely alter how the market responds to Abbott moving forward.
That’s basically the architecture behind the Markov chain logic that I use throughout my articles. Essentially, the future state depends on the current state.
As an analogy, consider an old, used baseball bat. Would you pay $10,000 for it? No, that would be unreasonable. But what if you knew that the bat was signed by the legendary Babe Ruth? At that point, you’d be crazy not to make the purchase.
What changed? Clearly, the bat remains a bat. So, the shift came in the perception of value — and what brought about the shift was the transition from one state to another. Previously, you saw a beat-up, old bat. Now, you see a beat-up, old bat that was signed by the Great Bambino.
I would suggest to you that it’s the same principle when it comes to Abbott Laboratories stock. It is and remains an equity share of a healthcare juggernaut. But right now, the market cares less about the juggernaut status and more so that it lost roughly 9% in the past 30 days.
As a basic presupposition, it’s reasonable to assume that the market will now treat ABT stock differently than if it were just cruising along, neither hot nor cold. Rather than just act on the presupposition itself — which would risk affirming the consequent — we can use data to justify a trading decision.
Quantifying Our Understanding of Abbott Labs Stock
Going back to the current behavioral state of ABT stock, we know that in the last 10 weeks, the ticker has only managed to print three up weeks. Quantitatively, we can label this particular sequence as 3-7-D: three up weeks, seven down weeks, downward slope across the total period.
Looking at roughly the last five years (since January 2022), we know that this 3-7-D sequence has flashed 19 times on a rolling basis. Over the next 10 weeks, we can calculate that the median distribution tends to range between $95 and $116, with probability density hitting its peak at around $103.
Another intriguing data point is that during the eighth week following the flashing of the aforementioned signal, Abbott Laboratories stock tends to shoot dramatically higher, enough so that there’s a 42.1% chance of ABT triggering the $110 price on the Nov. 20 expiration date.
That’s significant intel because, as of this writing, the $110 level is the lowest second-leg strike price available on the November monthly options chain that provides an asymmetric payout (above 100%) for vertical spreads.
Specifically, I’m looking at the 105/110 bull spread (expiring Nov. 20) as a tempting proposition. Mechanically, a speculator would pay a net debit of $165 in the hopes that ABT stock rises and triggers the $110 strike on expiration. If it does, the maximum payout would be $335, a payout of 203%.
That’s the type of idea you want to consider because you get back way more than you put in — provided that the spread works out as planned. That, of course, is the big question.
Why Face-Value Probabilities Shouldn’t be Automatically Accepted
At face value, the 105/110 bull spread has negative expected value (EV). That’s because the probability that ABT stock will actually hit $110 on expiration is only 22.03%. If you run an EV calculation, this trade, as it stands, suffers from a net payout value of -$54.86.
That’s not good. But it might be drawing an inference from the wrong meta.
Mathematically, the 22.03% figure is only true if we assume — as the underlying Black-Scholes model does — that ABT stock will undergo a random walk between now and the expiration date. However, a random walk is unlikely because of the current, bearish Markov state.
Historically, at least over the trailing five years, when the 3-7-D sequence flashes, the median response tends to be contrarian and positive, enough so that the odds of hitting $110 stand at 42.1%, not 22.03%.
When the Markov probability is integrated into the EV calculation, the trade would be expected to net +$45.48. And that’s the major difference between a random walk and a nonrandom one.
No, we cannot change the payout structure — Wall Street is not in the business of handing out free money. What we can do, though, is to apply the appropriate presuppositional framework. This wouldn’t guarantee success as the options market remains incredibly risky. Still, in terms of relative risk, there’s a decent chance that ABT stock could be favorably mispriced.
