When a publicly traded security drops 50% on a year-to-date basis like AeroVironment (NASDAQ: AVAV), it’s generally a good rule of thumb to avoid picking up the supposed discount. Sure, AVAV stock looks tempting. As a defense specialist focusing on autonomous weapons systems — particularly drones — AeroVironment is incredibly relevant. However, relevance doesn’t always guarantee positive outcomes.
If AVAV stock is about to show any sign of a recovery, even a dead-cat bounce, it’s doing a rather poor job. In the past 52 weeks, the ticker has slipped roughly 67%. After coming to prominence following Russia’s invasion of Ukraine, AVAV has often struggled to build off its peaky bouts of momentum.
Of course, there’s another side to this argument, and that’s the fundamental picture. We’ve generally had a feeling that the Ukraine crisis would continue to persist unless one side made a groundbreaking, penetrating assault. That really hasn’t happened, with the fighting essentially frozen along dense fire zones.
With the latest news that the Trump administration has waived broad new Russia sanctions, there’s little incentive for the aggressor to pull back now. Subsequently, the conflict will likely ramp up into a new phase, which may cynically lift sentiment for AeroVironment stock.
It’s a highly risky idea, mainly because it’s stupidly obvious. Further, geopolitical flashpoints — especially the kinetic ones — are extraordinarily difficult beasts to predict. With so many variables and nuances, there’s really no clean, narrative-based inference to make.
Still, there might be a quantitative argument for AVAV stock that the most aggressive speculator may consider.
Aiming for a Reversion to the Mean for AVAV Stock
Technically speaking, the case for AeroVironment stock is relatively straightforward. Despite being a relevant enterprise, the defense specialist has fallen amid a broader risk reassessment against key geopolitical backdrops. But with fighting in Ukraine likely to enter a new, aggressive phase — along with rising unrest in other areas — the risk reassessment may change again, this time positively.
Further, with so much bad news apparently baked into the AVAV stock price, upside resistance may be relatively limited. Naturally, it’s a huge gamble to bet against the current dominant trend. However, if you took the so-called conservative approach and merely “waited for confirmation,” if the confirming event does materialize, a premium valuation will also emerge — thus erasing the discount for which you were awaiting confirmation.
True, if you did wait and AeroVironment stock continued to tumble instead, you’ll thank yourself for waiting. Like I said, it’s a gamble — and there’s no guaranteed, safe way to do it.
What I will say is that AVAV stock is currently structured in a deeply bearish state; that’s not disputed by anyone serious. But according to historical data over the last five years, whenever this state has flashed in the technical chart, there is typically a transition to a higher, bullish one.
We’re not interested in betting on the future state itself but rather the transition. Prior to a possible move higher, we may speculate on AVAV stock option spreads now. Better yet, the pricing of these options suggests a potentially favorable miscue.
Targeting a November Lift for AeroVironment Stock
If we assume the typical state-to-state transition, there may be an outside chance that AVAV stock may trigger the second leg of the 130/140 bull call spread expiring Nov. 20. If this event occurs, the $340 net debit (cash outlay) used to enter the trade would convert to a $660 maximum profit, a payout of over 194%.
On paper, it’s an attractive idea because you have a chance of getting back almost twice as much as you put in, which is another way of saying that the trade offers favorable payout asymmetry. Plus, $340 isn’t too terrible of a cost in nominal terms.
However, the challenges mainly center on the probabilistic risk. With this November bull spread, the breakeven price comes in at $133.40 on expiration, meaning that the threshold sits some 9.53% away from the current AVAV stock price. Wall Street’s options-pricing mechanism (Black-Scholes) assigns a probability of profit (breakeven) of 29.8%.
Even more challenging, the odds of actually hitting $140 on Nov. 20 sit at only 18.05%. If you run the above parameters of this spread in an expected value (EV) calculator, you’d get an EV of $159.50 below zero. That would translate to an expected return on capital (ROC) of -46.91%.
Almost certainly, any professional financial consultant will steer you away from this “opportunity” — but it all raises a question. What if we could change the core parameters of the trade?
A New Probabilistic Framework May Be Required
If it were possible, the most straightforward solution would simply be to get more payout for the $140 spread. As mentioned earlier, the listed payout (as of this writing) is 194.12%. If this number were to magically rise to 600%, that would make the wager a no-brainer.
Unfortunately, we can’t just demand a greater payout without also agreeing to a higher probabilistic risk. So, what’s the next best thing? We change the probability of our trade.
There’s a common misunderstanding that somehow the probabilities assigned to options trades are handed down by thunderous decree from Mt. Apollo. Rest assured, nothing could be further from the truth.
Here’s the dirty little secret: if you assume that AVAV stock will undergo a random walk between now and the Nov. 20 expiration date, then yes, those probabilities that I just mentioned are completely relevant and appropriate. However, the core dispute is whether AVAV will indeed traverse randomly.
I very much doubt that it will. In the last two months, AeroVironment stock printed 10 weekly candlesticks in the technical chart. Of this figure, only three of the candlesticks resulted in net positive price action, where the closing price on Friday was higher than the opening price on Monday.
This particularly bearish sequence has only materialized 19 times on a rolling basis over the last five years. When it has flashed, the frequency of contrarian bullishness has been enough so that it’s plausible that the odds of AVAV stock reaching $140 on expiration are between 36.8% and 42.1%.
Recalculating EV for the Bull Spread
Basically, the analysis is as follows. If you believe that AeroVironment stock will trade randomly to the November expiration, you’re looking at a low-probability trade you should avoid. However, if you believe that AVAV will undergo a nonrandom walk — and subsequently transition from a bearish state to a bullish one — the odds of success (while still nominally low) improve significantly.
At a nonrandomly adjusted probability of 36.8%, the aforementioned November spread would have an EV of $28, or an expected ROC of +8.24%. At a probability of 42.1%, EV rises to $72, translating to an ROC of +21.18%.
Granted, AVAV stock remains a high-risk play, no matter how you cut it. But with an adjusted probabilistic framework, there’s a real speculative case here.
