Options Corner: Wall Street's Blind Spot On SoundHound AI Sets Up A Bullish Edge

Although artificial intelligence specialist SoundHound AI Inc SOUN represents one of the more innovative entities in the broader digitalization movement, it's also fair to point out that its equity suffers from wild valuation swings. For example, SOUN stock has nearly doubled in value over the past year. But from the beginning of this year, it's down 51%. Still, the volatility also facilitates opportunity for speculators.

Recently, SOUN stock has pulled back from a swing in positive momentum last week. Much of the choppiness has been centered on SoundHound's mixed performance in the first quarter. On May 8, the tech specialist — which specializes in conversational assistance and voice-enabled applications — posted revenue of $29.13 million.

By comparison to last year, the sales tally represented 151% growth, an achievement sparked by strategic acquisitions and strong demand from the automotive and restaurant sectors. While encouraging, the end result missed analysts' consensus target of $30.38 million.

Adding to the pressure, the options market lit up last week, with sweep transactions for sold calls hitting SOUN stock. Essentially the institutional version of a market order, sweep transactions suggest a heightened tempo to secure the trade quickly. This transaction has bearish implications because the trader is underwriting the risk — due to uncertainty — that SOUN will not rise above the profitability threshold by expiration.

Thanks to the wide-ranging pessimism, short interest in SoundHound is sky-high at 30.7% of its float. What's more, the short interest ratio stands at 5.31 days to cover, meaning that traders will require at least a week to unwind their bearish positions based on average trading volume.

Translation? Given the popularity of SOUN stock among retail traders, the red ink could be viewed as a discount. If so, the bears might find themselves on the wrong end of the barrel, thus setting off a short squeeze.

Market Breadth May Fan The Flames Of SOUN Stock

As pet food products specialist Freshpet Inc FRPT recently demonstrated, short squeezes can be quite powerful. Earlier this month, FRPT's short interest popped to 15.3%. And even though much of the upswing had already materialized by the time I discussed the trading idea, I stated at the time that there was still room for growth.

Although the price discovery process was incredibly choppy, the proof is in the receipt: the short squeeze helped drive the share price higher.

With SOUN stock, the situation is arguably even more compelling for risk-takers. Generative AI and its practical applications are intensely popular talking points. Further, SOUN's short interest is double that of FRPT, with nearly identical days to cover. Subsequently, the upside could be robust.

Fueling this speculation is market breadth data. Currently, SOUN is riding a "3-7-D" sequence: three up weeks mixed with seven down weeks, with a net negative trajectory across the 10-week period. Notably, in 58.33% of cases, the following week's price action resulted in upside, with a median return of 13.58%.

Under "normal" conditions, SOUN stock features a negative bias. Statistically, the chance that a long position will be profitable on any given week is only 47.5%. For context, a stable blue chip will usually feature long-side odds of around 52% — a tiny edge that theoretically favors the bullish investor over a lengthy period.

With SOUN stock, the market is pricing shares with the assumption of this negative bias. However, the aforementioned market breadth data shows that in the current sentiment regime, the odds favor speculation.

By deduction, then, the previously mentioned sold call may be the wrong move. When the odds favor a directional swing — either bullish or bearish — the incentivization shifts toward a debit-based transaction.

In other words, the trader is incentivized to buy the probability, not sell the uncertainty.

Advantaging Potentially Mispriced Options

Because of the wild volatility of SOUN stock, market makers are extremely skeptical about the equity. Traders can use this potential mispricing to their advantage.

Take for example the 10/10.50 bull call spread expiring June 6. This transaction involves buying the $10 call and simultaneously selling the $10.50 call, for a net debit paid of $19. Should SOUN stock rise through the short strike price at expiration, the maximum reward is $31, a payout of over 163%.

Primarily, this trade is attractive because, as stated earlier, market makers are assuming a negative bias in SOUN stock. And they would be correct in most circumstances. However, the current market breadth setup suggests that the odds have tilted in favor of the bulls, making the above call spread awfully tempting.

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