While clinical laboratory Quest Diagnostics (DGX) had a rough outing last week, speculators seeking a discount may want to keep DGX stock on their radar. In the trailing five sessions, the equity dropped nearly 4%. Over the past month, it’s down just over 6%. While the volatility may be alarming ahead of its upcoming earnings report (scheduled for July 22), there’s intriguing evidence of a possible bounce back.
First, one could potentially read between the lines regarding its derivative market activities. Last Friday, DGX stock represented one of the highlights of Barchart’s screener for unusual stock options volume. Specifically, total volume hit 4,717 contracts, representing a 353.12% lift over the trailing one-month average. However, put volume dramatically outpaced call volume, 4,201 contracts to 516.
At first glance, the above setup may sound like bad news. After all, put options give unit holders the right (but not the obligation) to sell the underlying security at the listed strike price. Still, we must remember that for every option contract bought, there is a seller involved. Thus, it’s not just about the volume of options but who is doing the transacting.
Drilling deeper into the details, DGX’s options flow screener — which focuses exclusively on big block transactions likely placed by institutional investors — showed that on Friday, net trade sentiment stood at $451,000 above parity, favoring the bulls. As it turned out, the high volume of put options were credit-based puts, meaning that institutional players were either neutral to somewhat bullish.
To be sure, you want to avoid reading too much into unusual options activity. At the end of the day, sentiment in the derivatives sphere is largely an inference — and inferences can be wrong. But there’s another reason to consider DGX stock and that’s the statistical setup.
Using the Power of Applied Game Theory to Decipher DGX Stock
In my opinion, one of the most intuitive mechanisms to trade stocks and options is to use applied game theory. In the context of the financial market, game theory essentially revolves around making moves when the odds favor you and avoiding certain ideas when they don’t. However, to use game theory requires an appropriate framework.
To best illustrate this process, it’s helpful to consider this thought experiment. Imagine flipping a coin a hundred times every business day. What you flip on Monday will have no bearing on what you flip on Tuesday, for the obvious reason that coin tosses represent random events. It stands to reason that if the market were also random, sentiment that materialized on one day would have no impact on the next.
Indeed, if the equities market were truly random, the financial publication industry would evaporate. There would be no point reading anyone’s opinion about a compelling opportunity considering the lack of a probabilistic edge.
However, that’s not what we observe. In the case of DGX stock, its price action compressed into market breadth sequences over rolling 10-week intervals reveals the following demand structure:
L10 Category |
Up Probability |
Baseline Probability |
Median Return if Up |
1-9-D |
100.00% |
55.00% |
1.74% |
2-8-D |
66.67% |
55.00% |
4.92% |
3-7-D |
52.63% |
55.00% |
2.62% |
4-6-D |
70.00% |
55.00% |
1.92% |
4-6-U |
41.18% |
55.00% |
1.11% |
5-5-D |
57.14% |
55.00% |
2.55% |
5-5-U |
59.52% |
55.00% |
1.78% |
6-4-D |
55.56% |
55.00% |
3.20% |
6-4-U |
54.24% |
55.00% |
1.43% |
7-3-D |
50.00% |
55.00% |
12.18% |
7-3-U |
44.64% |
55.00% |
1.41% |
8-2-D |
50.00% |
55.00% |
4.71% |
8-2-U |
64.00% |
55.00% |
1.00% |
9-1-U |
0.00% |
55.00% |
N/A |
In the past two months, DGX stock has printed a 4-6-D sequence: four up weeks, six down weeks, with a negative trajectory across the 10-week period. Since January 2019, this sequence has materialized 40 times. What’s more, in 70% of cases, the following week’s price action results in upside, with a median return of 1.92%. Should the bulls maintain control for a second week, the added median performance stands at 1.96%.
On Friday, DGX stock closed at $168.09. Based on past analogs (that is, the number of times that the 4-6-D flashed), it’s possible that DGX may be on course to reach $174.68, perhaps up to $175 within the next two weeks.
A Risky Move to Consider
For those interested in betting on a sentiment reversal, the 175/180 bull call spread expiring Aug. 15 could be intriguing. This transaction involves buying the $175 call and simultaneously selling the $180 call, for a net debit paid of $265. Should DGX stock rise through the short strike price at expiration, the maximum reward is $235, a payout of nearly 89%.
The main risk here is reaching the short strike price. Based on past analogs, DGX stock has a realistic chance of breaching $175 by expiration. Getting to the short strike price of $180 is a trickier proposition. What could work in favor of the bulls, though, is that the 4-6-D historically attracts bullish interest.
Because of the relatively steep 6% trailing-month loss in the equity, it’s possible that any counterresponse could be more robust than usual.
