Objectively, Honeywell (NASDAQ: HON) currently doesn’t look like a top-tier investment nor as a particularly intriguing debit-side bullish trade. Over the trailing month, HON stock has lost nearly 16%, which suggests underlying fundamental pressures. At the same time, if we accept the concept of mean reversion, Honeywell may be a prime candidate.
Of course, this assumption doesn’t necessarily mean that all securities that suffer serious downturns represent a buying opportunity. However, Honeywell is effectively a blue chip, an industry stalwart, particularly in the automation specialties. That’s going to be more relevant, especially as artificial intelligence scales upward. As such, any time HON stock incurs deep, extended pessimism, it would naturally lend itself to contrarian thinking.
Indeed, one could argue that the fundamentals themselves, while they currently look poor, offer the possibility of a bullish case. According to Google Finance’s summary sheet, “Honeywell declined approximately 16.5% over the past month due to sector-wide industrial caution and disappointing results from its recently spun-off aerospace unit. Nevertheless, analysts project a steady recovery for next quarter, as market consensus suggests the core business will benefit from a robust automation backlog and positive post-separation margin expansion.”
If it’s true that analysts project a near-term recovery in the business, it may follow suit that Honeywell stock could see an uplift. Therefore, the idea of mean reversion wouldn’t just materialize out of the ether — there’s a substantive basis for optimism.
What may benefit options traders right now is that the market apparently doesn’t share the same belief. In the trailing week, for example, HON stock is down more than 3%. I’m writing this analysis following Thursday’s close and looking at the after-hours session, bearishness continues to be the dominant sentiment.
So, the strategy wouldn’t be to wait until the Honeywell stock price catches up to the supposedly positive fundamentals. For the contrarian, it would be to consider diving into the weakness right now.
HON Stock is Technically a Longshot Opportunity
Even if you were to adopt the contrarian view for Honeywell stock, the current pricing mechanism for the ticker is aligned for rather robust risk-taking. At the time of writing, HON is trading hands at $207.63. Looking at the available options spreads for the Oct. 16 expiration date, the smallest spreads that still feature a triple-digit maximum payout are the ones anchored to the $230 second-leg strike price.
Of course, the wider spreads — such as the 200/230, which features a 143.9% max payout — are more probabilistically forgiving due to a lower breakeven price but are much more expensive from a net debit perspective. With this one, the cash outlay required is $1,230 per spread.
Some people might prefer the 220/230 bull spread, which features a relatively low net debit of $230. Should HON stock rise through the $230 strike at expiration, the maximum profit would be $670, a payout of just over 203%. Obviously, that sounds enticing, but there’s a catch — Wall Street assigns low odds of success.
With this particular trade, the breakeven price is $223.30, which is 7.55% higher than the time-of-writing spot price. Per the Street’s options pricing mechanism, you’re looking at odds of only 22.4%. That’s just to not lose money on the trade. The actual chance of Honeywell stock triggering the $230 strike on Oct. 16 is 14.38%.
Under such probabilities, it really wouldn’t make sense to consider HON stock. Even if the goal was to draw even, that probability is incredibly low at 22.4%. Therefore, under the standard options pricing mechanism — which is some derivative of the Black-Scholes family of calculations — you should walk away from Honeywell without a second thought.
A Random Walk Versus a Nonrandom Walk
I’m not suggesting that mean reversion as a framework is enough of a justification to ignore the Black-Scholes-derived datapoints. Sometimes, there may be a case of setting aside this evidence. But in this example, the numbers appear quite decisive: HON stock is extremely risky from a probabilistic sense.
Nevertheless, you should be aware (before you make your final decision) of the premises that undergird Black-Scholes. Like any model for the unknown future, the framework is presuppositional — it has assumptions that aren’t epistemologically neutral.
To make a long story short, Black-Scholes assumes that Honeywell stock will undergo a random walk between now and the expiration date, with the current implied volatility (IV) serving as the constant “fuel” throughout the journey. This environment makes the model risk-neutral, but that doesn’t mean the model is epistemologically neutral — the presupposition that HON will traverse along a random, risk-neutral path is ultimately an argument that must be defended.
Personally, I refuse to just grant that HON stock will trade randomly. In my view, Honeywell will trade nonrandomly due to its current order-flow imbalance. In the last 10 weeks, HON only printed three positive weekly candlesticks. Within this time period, it can be reasonably assumed that at least some of the weak hands have been flushed out.
If that is the case, there would seem to be a higher probability that institutional players may view HON stock as a relative discount. In other words, there should be a nonrandom influencing agent — stemming from the 3-7-D quantitative sequence — that makes the contrarian argument more likely.
Running the Conditional Odds for Honeywell Stock
Based on empirical data since January 2019, we know as a discretized fact that the 3-7-D signal has flashed 18 times on a rolling basis. Of this tally, HON stock has triggered the equivalent of the $230 strike price six times on week 6 (approximately Oct. 16). As such, the conditional odds for HON may be 33.3%.
That’s still terrible odds, but relatively speaking, it’s much better than 14.38%. More critically, the odds of breaking even stand at 50% since HON stock has triggered the $223.30 threshold nine times.
Does that make Honeywell stock a solid trade? Frankly, it really depends on your particular situation. From a strictly conservative view, I would say that Honeywell should be avoided. You could opt for the more probabilistically sensible 210/220 bull spread. But with a max payout of 85.19% and a net debit required of $540, this spread arguably isn’t the most efficient use of your risk capital, especially in light of other alternatives.
Now, if you’re specifically talking about making longshot trades on blue chips with money you can afford to lose, then the Oct. 16 220/230 bull spread may make sense. You just have to think carefully about your own individual risk tolerance.
