Why Tumbling Data Center Provider Vertiv Can Upload A Sentiment Reversal - Vertiv Holdings (NYSE:VRT)

For the midweek session on Wednesday, Vertiv Holdings Co VRT — which provides critical infrastructure for data centers and communication networks — happens to be one of the biggest losers among large-capitalization stocks. During the early afternoon session, VRT dropped more than 5%. Of course, with Vertiv being one of the many components of the value chain supporting artificial intelligence, there's a natural temptation to buy the dip.

I'm not going to dispute this general line of reasoning: I do believe upside in VRT stock is possible. However, a quantitative model is much more appropriate for forecasting where VRT may end up, and just as importantly for options traders, when.

Since April of this year, I switched from analyzing publicly traded securities based on their price trends to assessing their behavioral states and their transitions, under a framework known broadly as discrete-event analysis. One of the core advantages of discretization and integrating the principles of Russian mathematician Andrey Markov is epistemological continuity.

Currently, traditional analytical processes assign discrete labels (such as "good value") to continuous scalar signals such as share prices. However, this juxtaposition imposes a category error as discrete states and scalar signals occupy different domains of reality. Therefore, when analysts map one methodology on top of the other without a structural translation, the output is vulnerable to distortions.

Further, not only does discrete-event analysis maintain epistemological continuity, the Markovian framework that I integrate is a descriptive model rather than prescriptive. Instead of estimating a range of upside and downside probabilities and narrowing the margin of error, I look at what has happened in the past and extrapolate forward a likely scenario.

Now, the burning question: does it work? I believe there's compelling evidence that it's a far superior model to traditional western approaches of forecasting stock prices for short-term trading purposes. Case in point is the Best Buy Co Inc BBY options story I wrote last month.

BBY stock is one of the hottest stocks this week, having gained over 5%. It's also well on its way to making the Aug. 15 67.50/70.00 bull call spread fully profitable. Mathematically, what's really fascinating is not so much the accurate call but that BBY largely gyrated within the forecasted positive and negative pathways:

Essentially, the chart above is the proof of concept: the probability of being right on both sides of the forecast by luck alone is low enough that it suggests my process captured real structure in the data.

Applying Discrete-State Logic to VRT Stock

Another key advantage of working under a discretized framework is that it organically lends itself to using first-order principles or concepts that cannot be mathematically reduced. In contrast, I'm not a big fan of solely relying on valuation ratios because they're philosophical derivatives of share price and some other metric. Further, neither the price nor the financial metric has any objective meaning.

The beauty of the authentic discretized framework is that it relies on the objective truth of the equities sector: at the end of the day, the market is either a net buyer or a net seller.

Using this logic, if we look back at the trailing 10 weeks (including this one), the market voted to buy VRT stock six times and sell four times. During this period, the security enjoyed an upward trajectory. For brevity, we can label this sequence as 6-4-U.

We now have a categorizable (and falsifiable) behavioral state. Looking back at the price history of VRT stock, we can extract how many times this sequence has materialized on a rolling basis. More importantly, we can estimate — through the study of past analogs — how the market responds to the sequence and extrapolate the data forward.

Now, before jumping into any trading setup, we must ensure that a probabilistic edge is available; otherwise, there would be no point. So, we can establish the null hypothesis — the assumption of no mispricing — by calculating the baseline odds for VRT stock. In other words, the chance that a long position in VRT will rise on any given week is 55.2%.

That's a pretty high baseline, so again, whatever trading proposition is forwarded, it has to beat the null, so to speak. The 6-4-U sequence? Based on the data available, it does just that, providing a next-week upside probability of 60.87%. Further, assuming the positive pathway, the expected median upside return is 3.8%.

Let's assume that VRT stock can reach $135.50 by the end of this week. Should the implications of the 6-4-U sequence hold true, the security may reach $140.65 relatively quickly.

As you saw from the Best Buy narrative and the comparison between forecasted and actual performance, exogenous factors can swing securities between the positive and negative pathways. Therefore, traders may consider giving themselves as much time cushion as they're comfortable with without excessively sacrificing net return potential.

Formulating an Options Strategy for Vertiv

Based on the market intelligence above, the 135/140 bull call spread expiring Sep. 19 appears attractive. This transaction involves buying the $135 call and simultaneously selling the $140 call, for a net debit paid of $250 (the most that can be lost in the trade). Should VRT stock rise through the short strike price ($140) at expiration, the maximum profit is also $250, a 100% payout.

A similar idea to consider is the 137/140 bull call spread expiring Sep. 5. Here, the net debit required is cheaper at $150, yet the payout is the same at 100%. This might be more enticing for options traders as you're not paying for additional time to expiration that could be unnecessary. However, the tradeoff is that if VRT stock unexpectedly falls into the negative pathway, the position might not return to profitability in time.

A key disclosure that you should be aware of is that after running a one-tailed binomial test on the empirical viability of the 6-4-U sequence, the outcome was a p-value of 0.2469. Colloquially, this means that there's a 24.69% chance that the implications of the signal could occur randomly as opposed to intentionally.

Does that mean the probability is "bad?" No, it just means that the observed result is not statistically rare enough to confidently reject randomness as an explanation. That said, because the baseline is already quite high, my argument is that the 6-4-U sequence enhances the naturally positive odds, thereby justifying a buy-the-dips mentality.

The opinions and views expressed in this content are those of the individual author and do not necessarily reflect the views of Benzinga. Benzinga is not responsible for the accuracy or reliability of any information provided herein. This content is for informational purposes only and should not be misconstrued as investment advice or a recommendation to buy or sell any security. Readers are asked not to rely on the opinions or information herein, and encouraged to do their own due diligence before making investing decisions.

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