Options Corner: Public Storage's Lull Ahead Of Q2 Earnings Could Point To An Outsized Move

In the heart of the second-quarter earnings season, self-storage giant Public Storage (NYSE:PSA) might not rank as one of the more exciting names. Indeed, you could make the argument that it's one of the less-inspiring scheduled events. Since the start of the year, PSA stock has dipped almost 4%, a consequence of broader industry softness. Yet the potential calm before the storm could make PSA intriguing for bold speculators.

First, it's quite possible that low expectations may provide a tailwind for Public Storage when it releases second-quarter results on Wednesday after the close. Frankly, the company hasn't had a great record, consistently missing against analysts' expectations for revenue — and occasionally falling short of bottom-line targets as well. Obviously, that's not great but with the bar lowered, a decent result may lead to an outsized move for PSA stock.

Second and more specific to the industry, Public Storage may stand on relatively favorable ground. Yes, the self-storage sector has suffered softening demand in the past two years. However, data compiled by CRE Daily showed that storage rentals in several markets saw rent increases, stemming in part from slowing development pipelines. As a result, Public Storage may be under less pressure in certain key markets to reduce rents.

Third, the economy itself features generational transitions that may cynically bolster PSA stock. Primarily, you'd have to look at the baby boomer generation, which is retiring en masse. Typically, retirement involves downsizing due to a lesser need to maintain a large abode. Further, younger demographics are resorting to extra jobs and other mechanisms to get closer to homeownership — indicating delayed purchases.

Yet life moves forward and with it comes the accumulation of stuff. Hence, it's possible, perhaps even probable, that Public Storage could be a beneficiary.

Getting Down To The Empirical Sentiment Behind PSA Stock

As compelling as the narrative above is, there are two major problems with it — at least if you're looking at the matter from an options trader. Number one, it's just my opinion and I would be delusional to believe that the market would move on that alone. Number two, if the opinion is either obvious or reasonable, then it has more than likely been priced into PSA stock.

To find a tangible edge, we must view the market not as a collection of prices but as a sentiment voting record. The problem with the share price as an analytical base is that it's a continuous scalar signal, meaning that it's unbounded. Right now, PSA stock trades at around $287. While people may be tempted to label this price as being "good" or "bad," the assessment would be relative — there's no objective mechanism to define goodness and badness.

Just about the only objective truth we have is that, in the trailing 10 weeks, the market voted to buy PSA stock three times and voted to sell seven times. From the beginning of this period to the end, PSA incurred a downward trajectory. We can abbreviate this sequence as 3-7-D.

At first glance, it may look ridiculous to compress the price magnitude dynamics of PSA stock into a simple binary code. But the beauty here is that we now have a quantifiable, falsifiable sequence that serves as the basis for past analogs. We can then create a demand profile for PSA, with the aim of understanding how the market responds to different sequences:

As a baseline, the chance that a long position in PSA stock will rise on any given week is 53.22%. This is essentially our null hypothesis, the assumption that there is no mispricing, no edge by which we can exploit. However, what I'm proposing is the alternative hypothesis, that when the 3-7-D sequence flashes, the one-week upside probability is 68.18%.

Further, assuming the positive pathway, the median expected return is 3.3%. Based on past analogs, should the bulls maintain control of the market for a second week, the expected performance boost is an additional 1.3%. With PSA stock trading around $287, it may be on course to reach approximately $300.33.

Putting The Numbers To Work

Based on the statistical analysis above, the 290/300 bull call spread expiring Aug. 15 is a tempting idea. This transaction involves buying the $290 call and simultaneously selling the $300 call, for a net debit paid of $445 (the most that can be lost in the trade). Should PSA stock rise through the short strike price ($300) at expiration, the maximum reward is $555, a payout of nearly 125%.

To be sure, prospective traders must keep in mind two key risks. Obviously, much will hinge on the upcoming earnings report. If Public Storage flounders, then this trade will probably not pan out and you risk losing the entire debit paid. As well, there's no guarantee that the implications of the 3-7-D sequence will pan out.

What I can tell you is that running a one-tailed binomial test on the sequence reveals a p-value of 0.1182. This means that there's a 11.82% chance that its forward implications may materialize randomly rather than "intentionally." In the scientific realm, that's not considered statistically significant. However, I would make the argument that the stock market's open, entropic system allows for empirical wiggle room.

Besides, we're not trying to formulate the theory of everything. We're just trying to look for an asymmetric edge. With relatively few people paying attention to PSA stock — even though it's flashing a quantitative reversal signal — this could be an opportunity to consider a contrarian position.

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.

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