By arguably most people’s standard of logic, Aurora Innovation (NASDAQ: AUR) is a speculative name to avoid. Sure, an apologist for the autonomous driving technology specialist could point to AUR stock gaining over 44% on a year-to-date basis. At the same time, AUR is vulnerable to instances of flash volatility, as Monday’s session demonstrated.
On Sep. 28, AUR stock suffered a sizable drop of more than 12%. While it’s difficult to pinpoint what may have caused that particular drawdown, we do know from Google Finance’s summary sheet that Aurora enjoys speculative support from those who see the potential of the business. Specifically, aggressive commercial contract targets and the deployment of next-generation driverless hardware underscore the bullish argument.
Of course, Aurora Innovation stock is barely trading above common thresholds for penny-stock pricing, and that’s where some of the concerns lie. Further, lingering profitability gaps — despite impressive growth projections — translate into an enterprise that remains unprofitable. Also, recently missing quarterly consensus expectations don’t help the fundamental argument.
If that weren’t enough, recent insider selling activity makes observers hit the “pause” button on AUR stock. To be fair, key stakeholders may reduce their exposure for a variety of reasons — and not necessarily nefarious ones. Still, to say that this isn’t a distraction given where Aurora stands now would be quite a stretch.
Given the pessimism that has sparked within the immediate timeframe, it’s no surprise that the balance of order flow is net bearish. Quantitatively, we know that in the last two months, 10 weekly candlesticks were posted in the technical chart — only four of these weekly sessions saw net positive price action, leading to an overall downward slope across the 10-week period.
Stated differently, 60% of the unit-wise volume of the defined period featured drawdowns, which may present an intriguing consequence in terms of probabilistic trajectory.
Understanding the Markov Chain Logic Behind AUR Stock
As you can see from my prior work, I don’t make assumptions about a particular security being undervalued relative to an often-unexpressed and unevidenced claim of a justified higher valuation. That type of logic often falls prey to the affirming the consequent fallacy. Instead, I focus on the probability of transition from one behavioral state to another.
Regarding Aurora Innovation stock, the fact that it flashed the quantitative signal that it did — four up weeks, six down weeks, and an overall downward slope (4-6-D) — is significant primarily because it heightens the likelihood of a transition occurring.
Currently, we can say that AUR stock is structured in a modestly bearish state; again, we have seen (over a defined period) more instances of selling pressure than buying pressure. That’s going to change the immediate perception of AUR and, as a result, will likely influence where the ticker heads next.
Imagine, for example, that you saw a rare exotic Italian supercar selling for $20,000. You’re tempted to buy it. But later, you find out that the vehicle was caught in a flash flood. Suddenly, the deal doesn’t seem so enticing. The car didn’t change, but the expectation of value did.
We may have a similar situation with Aurora Innovation stock. From a bird’s-eye view, AUR looks awfully speculative (and it is). However, with 60% of recent unit-wise volume incurring rather steep drawdowns, it raises the question of whether a transition to a different (and potentially bullish) state might occur.
That’s the heart of the Markov chain logic, which asserts that the future state of a system depends on the current state. Because the current state is modestly bearish from a quantitative view, we’re theorizing that the transition to the future state will be different compared to if AUR stock had structured itself in any other state.
Acknowledging this state-to-state transition will be critical in better determining appropriate probabilities for AUR stock moving forward.
Quantifying Our Ambitious Trade for Aurora Innovation Stock
Let’s look at intriguing bull call spreads as a reference point for analyzing AUR stock. One idea that may stand out to speculators is the 6/7 bull call spread expiring Nov. 20. Mechanically, this vertical spread requires a net debit (cash outlay) of $35. Should AUR rise through and trigger the $7 second-leg strike on expiration, this options play would generate a maximum profit of $65, a payout of nearly 186%.
On paper, this trade is favorably asymmetric to the debit-side speculator. You’re paying $35 and should everything go according to plan, you’re getting a profit of $65. Unfortunately, that’s where the fun ends. Right now, Wall Street’s options pricing mechanism pegs the probability of breakeven at only 31.3%.
What’s worse, OptionCharts.io’s Probability Distribution screener shows that the chance of Aurora Innovation stock hitting $7 on expiration day is only 18.96%. If you run the details into OddsJam.com’s Expected Value calculator, you’re looking at an EV of about $16 below parity. That’s not good.
At the same time, you shouldn’t necessarily take the provided probabilities at face value. These success ratios stem from the Black-Scholes family of calculations, which presupposes a risk-neutral, random-walk environment. So these odds would only be accurate if we presuppose that the price discovery process of AUR stock will be random from now until expiration.
Is that a justified presupposition? I don’t think so, and that’s because of what I had mentioned earlier: Aurora Innovation stock is currently structured in a modestly bearish state. And as such, we need to calculate the probability of transition to another state before making a decision.
Circumstances Take an Intriguing Turn
Here’s the conflict with AUR stock. Since its public market debut (as a SPAC merger), we know that the 4-6-D sequence has flashed 25 times on a rolling basis. We also know that when this signal does flash, the median outcome is for AUR to crash.
On a good day, it can clear the $7 target on the Nov. 20 expiration date. But based on this model, that’s only about a 27% chance of success. That might be better odds than what the Black-Scholes model provides, but the net EV on this trade would still be negative ($8 below parity).
However, if we apply recency bias to the Markov chain logic by starting our analysis on January 2024, the probabilities completely change. In this admittedly limited sample size, the basic probability of AUR stock hitting $7 on expiration shoots up to 53.8%.
If that actually turns out to be the case, the EV on the aforementioned bull spread would clock in at $18.85. Even if we were to penalize the probability down to 43% — to account for the small sample size — we would still be looking at an EV of +$8.04.
To be clear, I’m not suggesting that Aurora Innovation stock is a clear buy. This is still an incredibly risky idea. But it’s also fair to point out that extreme speculators may have an interesting argument here.
