Options Corner: Why Hewlett Packard Enterprise's Death Cross Could Be A Contrarian Indicator

Just by the sound of it, shareholders of Hewlett Packard Enterprise Co. HPE should be shaking in fear: HPE stock recently printed the Death Cross in its price chart. Often regarded as a warning before a serious downturn or even a bear market, the pattern theoretically allows investors to exit or take protective measures with options-focused strategies.

On March 25, HPE stock ended the day at $16.52, a slight improvement over the prior session. Unfortunately, prior volatile trades meant that the equity's 50-day moving average slipped beneath the 200 DMA, thus flashing the Death Cross.

On paper, the signal represents a simple arithmetic phenomenon. Fundamentally, though, the Death Cross symbolizes fading momentum and a possible sign that the security in question could be entering a longer-term downtrend.

Adding to the downbeat assessment, Benzinga's options scanner identified net bearish activity in HPE stock on the same day that the Death Cross flashed. While every market participant effectively has an opinion, some opinions are frankly more important than others. When the whales position themselves in a particular way, it's always worth paying attention to.

After all, the whales have access to the best resources and hire the smartest people. If institutional investors sense danger, it's not wise to ignore the alert. Still, there is critical context to consider before writing off HPE stock.

The Death Cross in HPE Stock Might be a Discount

While ominous clouds may be circling HPE stock, it's important to understand the nuances. First, the aforementioned bearish unusual options activity largely represents skepticism that HPE will move significantly higher rather than a "direct" wager that it will fall.

From the options scanner report, Benzinga readers will notice that the biggest bearish sentiment trades were call options. Since calls give holders the right (but not the obligation) to buy the underlying security at the listed strike price, by logical deduction, a bearish call is a sold contract; that is, call sellers are underwriting the risk that the target security will not rise.

If the stocks in question move above their breakeven thresholds, then call sellers must sell the underlying security if call holders exercise, a process known as assignment. Since naked calls represent extremely dangerous exposure, one can reasonably assume that call sellers own the securities that they are writing the options against.

In other words, a sold call's strike price plus the premium received from selling said call effectively represents the price participating investors are comfortable selling the underlying security. For HPE stock, the sold calls imply that there is upside risk (from the bears' perspective) that it could hit $17.45 to $18.38 from now to June of next year. That's pessimistic, but it doesn't necessarily mean that institutional investors anticipate an imminent drop.

What's more, the Death Cross has historically signaled a discounted opportunity in HPE stock, at least from a near-term trading perspective. In the trailing decade, HPE stock has printed seven Death Crosses (not including the most recent incidence). One month after this signal flashed, HPE has risen four times or a contrarian success ratio of 57%.

Contextually, it might not be fair to include the Death Cross that materialized in March 2020 as most securities stumbled due to the unprecedented COVID-19 crisis. If that entry is removed, the contrarian success ratio would improve to four out of six, or nearly 67%.

Rolling the Dice on Hewlett Packard Enterprise

To be crystal clear, playing the Death Cross represents a high-risk, high-reward wager. The institutional players are skeptical about HPE stock. Further, the overall sentiment has been consistently poor, thereby attracting Wall Street's Grim Reaper. Nevertheless, contrarian moves tend to deliver massive payouts and that's the temptation here.

For those that want to go all-out, the 15.50/17.00 bull call spread for the options chain expiring April 25 is enticing. This trade involves buying the $15.50 call (at a time-of-writing ask of $98) and simultaneously selling the $17 call (at a bid of $28). The proceeds from the short call partially offset the debit paid for the long call, resulting in a net cash outlay of $70.

Should HPE stock reach $17 at expiration — thus implying about a 6.6% move — the maximum reward is $80, or a payout of over 114%. It's a stretch but not unreasonable. Under the positive scenario, a one-month return following the Death Cross has averaged 5.53%. Moreover, the Death Cross that flashed in February last year saw a one-month bump of 10.44%.

It's a super-risky bet; there's simply no denying this reality. However, there is a legitimate case for speculation based on the numbers.

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