Why AppLovin May Have More To Drop Before An Eventual Recovery - AppLovin (NASDAQ:APP)

Chances are, a cursory look at the financial publication ecosystem will reveal that mobile technology specialist AppLovin Corp. APP is a fantastic discounted opportunity. Due to multiple short-seller attacks, APP stock finds itself down around 26% in the past five sessions.

This extreme volatility has pushed APP's year-to-date performance into negative territory, with the stock now down 6% for the year, erasing its strong start. Still, investors may want to temper the dip-buying impulse.

To start, no questions exist regarding the dominant performance of APP stock. Over the past 52 weeks, the security returned around 450% — even with the horrific drop. However, the trouble emerged late last week when short-selling specialist The Bear Cave released a research report alleging ad fraud.

"The Bear Cave believes AppLovin’s rapid rise — up ~750% over the last year to around 35x revenue — is fueled by low-quality revenue growth from ads that are deceptive, predatory, and at times unreadable or unclickable," the short seller remarked.

Compounding matters was that on Wednesday, another short-seller report took the high valuation of APP stock to task. In the latest round, Fuzzy Panda Research accused AppLovin of stealing Meta Platforms Inc.‘s data, among other claims.

It's important to recognize that AppLovin CEO Adam Foroughi issued a letter to the company's shareholders, partners and team responding to the short-seller allegations. While Foroughi denies that AppLovin has the capability to reverse engineer Meta's ad data, some investors may be dissatisfied with the CEO's other rebuttals.

Arguably, the most damaging accusation relates to the issue of direct downloads, a matter which Culper Research — another short-selling specialist — shared with Fuzzy Panda. Foroughi stated that "[e]very download results from an explicit user choice." However, the CEO did not provide a rigorous defense of the core allegation of "silent installs."

APP Stock Faces a Historically Tough Road Ahead

To be sure, it's easy to understand why the retail crowd may view APP stock as a back-up-the-truck opportunity. Relative to its Valentine's Day closing price of $510.13, APP trades hands at about a 35% haircut. However, if the core allegations stick, the company would likely require a valuation adjustment.

Technically speaking, APP stock is treading in dangerous waters. Throughout this year, the security's 50-day moving average provided support. However, the combined short-seller attacks have driven sentiment below this critical barometer. Now, it's sandwiched between the 50 DMA at the top and the 200 DMA at the bottom (around $195).

Still, the statistical backdrop may be the most ominous warning sign. Under ordinary circumstances, APP stock enjoys an upward bias. Further, evidence shows that investors buy the dips — to a point. However, when extreme volatility suddenly emerges, the market tends to run away.

Using data extending back to its public market debut, a position entered at the beginning of the week has a 52.48% chance of rising by the end of it. Over an eight-week period, this baseline probability rises to 61.03%.

However, under dynamic conditions of extreme volatility, the stats don't look so inviting. Following a one-week loss of 15% or greater, the long odds in the subsequent week drop to 14.29%. Over an eight-week period, the dynamic probability does improve, but only to 28.57%.

In full transparency, there have only been seven instances when APP stock has incurred a 15%-plus weekly loss. Therefore, investors must consider the risk of distortion related to small datasets. Nevertheless, the combination of short-seller research, an arguably unconvincing response and weak technical data appears to bolster the statistical case against APP.

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Why AppLovin Faces More Downside Risk

Going back to the statistical framework, the issue is not just the likelihood of poor long-side trades; rather, it's that the projected range of price outcomes conspicuously tilts downward relative to the expected range of price outcomes under baseline conditions.

Using the market intelligence above and assuming the negative scenario wins out, APP stock runs the risk of incurring a median loss of 16.98% over the next three weeks. That would put a downside target of $273.98, assuming that APP finishes this week at $330.

For an aggressive trade with some margin for error, traders may consider the 310/300 bear put spread for the options chain expiring March 21. This transaction calls for buying the $310 put (at an ask of $2,070) and simultaneously selling the $300 put (at a bid of $1,600).

The trader would use the proceeds from the short put sale to partially offset the debit of the long put, resulting in a net debit paid of $470. If APP stock falls to or below the short put strike of $300 at expiration, the trader would collect $530 or a payout of almost 113%.

A much more aggressive trade — albeit with a cheaper net debit — is the 305/300 bear put spread expiring one week earlier on March 14. This transaction requires a cash outlay of $240 for the chance to earn $260, resulting in a 108.3% payout.

Choosing an expiration period is a speculative balancing act. While a longer period is "safer" in the sense that it gives more time for the directional thesis to pan out, if the spread becomes profitable prior to the expiration, traders wanting to exit early must account for the unnecessary time value, which becomes an opportunity cost.

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