Rivian Automotive Inc (NASDAQ:RIVN) hasn't exactly gotten off to a bright start for the new year, with RIVN stock losing roughly 25% since the beginning of January. Nevertheless, a positive earnings report could easily shift the narrative. Indeed, the moment of truth is arriving soon, with the electric-vehicle manufacturer scheduled to release its fourth-quarter results on Thursday after the market close. Even better, smart money rumblings imply confidence ahead of the disclosure.

First, let's look at the expected numbers. Wall Street analysts expect the bottom line to come in at a loss of 81 cents per share on revenue of $1.26 billion. In the year-ago quarter, Rivian posted a loss per share of 46 cents on revenue of $1.73 billion. These figures beat the consensus targets of a 65-cent loss and $1.43 billion, respectively.

Generally, after a shaky period between early 2022 and early 2023 — where Rivian only beat on revenue once in five reports — the EV maker has significantly improved its top-line performance relative to analysts' expectations. Investors will be hoping for more of the same, especially amid a challenging economic backdrop. If volatility skew is any indication, the smart money appears to be anticipating at least the possibility of upside in RIVN stock.

Volatility skew is a screener that identifies implied volatility (IV) — a stock's potential kinetic output — across the entire strike price spectrum of a given options chain. For the Feb. 13 weekly chain (which expires one day after earnings), the skew shows a clear prioritization of upside convexity.

On certain strikes above the spot price, call IV noticeably stands above put IV. For most of the above-spot strikes, put IV is modestly above call IV, which is what you would normally expect ahead of earnings for a name like RIVN stock: this is basically protection against a downturn. However, the selective call IV dominance potentially indicates belief in upside capability.

Combined with the deep in-the-money (ITM) calls, where call IV is clearly above put IV, the overall posture prioritizes bullish expression — with some hedging to the downside.

Establishing The Trading Parameters Of RIVN Stock

While we now have a general understanding of the possible sentiment of the smart money, we don't know how this may actually translate into price outcomes. For that, we may turn to the Black-Scholes model. Wall Street's standard mechanism for pricing options projects that for the Feb. 13 expiration date, RIVN stock may land between $13.22 and $16.44.

Where does this dispersion come from? Black-Scholes assumes a world where stock market returns are lognormally distributed. Under this framework, the above range represents where RIVN stock may symmetrically fall one standard deviation away from spot (while accounting for volatility and days to expiration).

Frankly, the projection is a reasonable one — which is why Wall Street uses it. Essentially, the math states that in 68% of cases, we would expect RIVN stock to trade within the prescribed range when Friday rolls around. However, we still don't know where RIVN is likely to end up.

At this point, we have reached the limit of first-order analyses. Sure, we can look at the unusual options activity for RIVN stock but the most significant, persistent trades should be reflected in the volatility skew. To recap, with this analysis, we have an understanding that smart money traders are prioritizing upside convexity. Further, the total activity in the options market implies a range between $13.22 and $16.44 for this Friday after earnings.

Here’s the cold, hard truth: even at this point, we're edgeless. We have educated ourselves to the point of a well-informed trader. But the problem is that we're competing with these traders, not seeking parity with them.

Essentially, we have on our hands the search-and-rescue (SAR) dilemma. RIVN stock is a shipwrecked survivor and it sent out a distress signal somewhere in the Pacific Ocean. Black-Scholes has identified a large patch of water as the search radius — and it's probably accurate. Of course, the problem is that we're talking about a massive search area (a peak-to-trough spread of over 24%).

To narrow this search area down, we must use probabilistic math. That's where the Markov property comes into frame.

Narrowing The Probability Space

Under Markov, the future state of a system depends entirely on the present state. Colloquially, forward probabilities should not be calculated independently but be assessed in context. When looking at the SAR analogy, different ocean currents — such as giant, powerful waves versus relatively still waters — can easily influence where a shipwrecked survivor is likely to drift.

Here's how we can use the Markov property for RIVN stock. In the last 10 weeks, RIVN printed only four up weeks, leading to an overall downward slope. There's nothing special about this 4-6-D sequence, per se. However, what this quantitative signal represents is a specific type of ocean current. In other words, a shipwrecked survivor will likely drift differently under 4-6-D conditions than had any other current materialized.

From here, we can use enumerative induction to estimate where RIVN stock may end up over the next 10 weeks based on how past occurrences of the 4-6-D sequence have played out. Because we're dealing with an environment of small sample sizes, we can also use Bayesian-inspired inference to better estimate projected drift patterns.

Assuming that you accept the premise, we find that over the next 10 weeks, RIVN stock may range between $13.50 and $18, with primary probability density peaking near $15.20 and secondary density peaking near $16.50.

Granted, we're talking about a 10-week fixed-time distribution while the earnings results will arrive this Thursday. However, Black-Scholes tells us that the high range (within a standard deviation) is $16.44. There's a reasonable possibility that, combined with smart money sentiments and the quantitative structure, RIVN stock could see enhanced kinesis come Friday morning.

With that in mind, perhaps the most tempting options trade is the 15.50/16.00 bull call spread expiring Feb. 13. You'd need RIVN stock to rise through the $16 strike, which appears to be an aggressive but plausible target. If so, you're looking at a maximum payout of over 163%. Enticingly, the net debit is only $19, which is the most that you can lose.

Add a breakeven price of $15.69 to help improve probabilistic credibility and you're looking at a very tempting binary proposition. Yes, the downside is that if earnings falter, you'll likely lose the trade entirely. But again, with a net debit of $19 per spread, it's tough to ignore.

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.

Image: Shutterstock

• No comments yet. Be the first to comment!