Options Corner: Salesforce's Upcoming Q4 Earnings Report May Help Right The Ship

Salesforce Inc (NYSE:CRM) may represent one of the leading names in cloud-based software applications and a case study in the productivity potential of artificial intelligence. Unfortunately, these attributes alone haven't exempted CRM stock from the tech sector rout that has cratered several top-tier innovators. Most worrying for Salesforce stakeholders, the company faces a serious test ahead of its fourth-quarter earnings report.

Scheduled for release on Feb. 25 after the closing bell, Wall Street analysts will be looking for earnings per share of $2.69 on revenue of $11.18 billion. In the year-ago quarter, the company posted EPS of $2.78 on revenue of $9.99 billion, beating the consensus EPS target of $2.61 but falling short of the $10.04 billion sales target.

Interestingly, CRM stock really hasn't been able to gain momentum since that report one year ago. Over the trailing 52 weeks, the security lost nearly 42%. And since the beginning of January of this year, CRM has fallen more than 30%. Despite the wave of red ink, though, the smart money doesn't seem overly concerned. If anything, the anxiety appears to be concentrated on upside convexity.

One of the most important indicators for retail traders to assess is volatility skew. Definitionally, the skew identifies implied volatility (IV) — or how much the selected stock is expected to move — across the entire strike price spectrum of a given options chain. Since IV is a residual metric derived from actual order flows, the underlying dispersion is based on an empirical estimate (rather than a random, handwaved number).

Essentially, volatility skew tells us what the "insurance premium" is for directional kinesis. Theoretically, if options flow were perfectly neutral, the skew would be flat. However, perceived risk is hardly ever neutral, especially for a name like CRM stock. And the key takeaway for the Feb. 27 weekly option chain is that smart money traders perceive greater risk to the upside than downside.

With the skew being noticeably distorted to the right side (toward higher strike prices), the positioning indicates hedging against a sudden breakout move. While there's no guarantee that CRM stock would indeed swing higher, such reflexivity is possible given its sustained terrible performance.

Calculating The Realistic Trading Parameters Of CRM Stock

While we now have a strong clue regarding the positional bias of the smart money, we still need to understand how this may translate into actual price outcomes. For that, we may turn to the Black-Scholes-derived expected move calculator. Wall Street's standard mechanism for pricing options anticipates that Salesforce stock will land between $163.80 and $205.64 for the Feb. 27 expiration date.

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 CRM stock may symmetrically fall one standard deviation away from spot (while accounting for volatility and days to expiration).

Mathematically, Black-Scholes asserts that in 68% of cases, Salesforce stock would be expected to trade within the prescribed range by the end of Friday next week. It's a reasonable assumption since movements above one standard deviation above spot are relatively rare. That said, the earnings report could add a serious wrinkle to this narrative.

Now, the conceptual sticking point with the expected move calculation is that we only know how the market is pricing uncertainty, not whether this pricing is rationally justified. To extract even more insights, we need to gravitate toward second-order analyses, which condition observed data based on an empirical anchor.

It's here that the classic search-and-rescue (SAR) conundrum does plenty of conceptual heavy lifting. If Salesforce stock symbolizes a lone shipwrecked survivor, then Black-Scholes would be the satellite system that has identified a distress signal pinging somewhere in the Pacific Ocean. From the signal, we can plot out a search radius based on theoretical drift patterns.

The problem? We live in a world of limited resources and can't conduct a full-on search effort covering the entire radius. To make the most efficient use of personnel and equipment, we need to rely on probabilistic math — math that incorporates influencing factors such as ocean currents to best estimate where CRM might be found.

This is where the Markov property comes into view.

Narrowing The Probability Space For Salesforce Stock

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. Extending the SAR analogy, different ocean currents — such as choppy waves versus calm waters — can easily influence where a shipwrecked survivor is likely to drift.

Here's how the Markov property relates to Salesforce stock. In the past five weeks, CRM printed only two up weeks, leading to an overall downward slope. There's nothing special about this 2-3-D sequence, per se. However, this quantitative signal represents a unique ocean current — and survivors caught in these waters would be expected to drift in a particular manner.

From here, we can use enumerative induction and Bayesian-inspired inference to best estimate where CRM stock may drift. Basically, the idea is to use past analogs of the 2-3-D sequence and apply the median pathway to the current spot price. This process allows us to map out a forward distribution.

For full transparency, David Hume's famous critique of inductive methodologies states that the future is not necessarily compelled by the past. In other words, there will always be the risk of the unknown, especially in the equities market. This applies to any kind of analysis: fundamental, technical, quantitative or some theoretical framework. My counterargument is that relative to second-order analyses, the Markov approach utilizes the fewest assumptions.

If you accept the premise above, the forward five-week distribution under 2-3-D conditions can be calculated to land between $180 and $198, with probability density peaking near $190. For those who want to speculate on a surprise earnings result, the 190/195 bull call spread expiring Feb. 27 could be intriguing.

For the trade to be fully profitable, CRM stock would need to rise through the $195 strike at expiration. If so, that would turn a $210 net debit into a $290 profit, a payout of over 138%. Breakeven lands at $192.10, which helps improve the trade's probabilistic credibility.

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