Intercontinental Exchange (ICE) Stock May Have a Favorable 20-Percentage-Point Disconnect

By itself, Intercontinental Exchange (ICE) isn't exactly what you would call a household name nor is ICE stock particularly regarded as a consensus upside opportunity (if the Barchart Technical Opinion rating of 88% Strong Sell is anything to go by). Heck, even the ticker has an unfortunate association among some partisan players. Nevertheless, it's a name that deserves close attention, especially because it could be favorably mispriced.

Fundamentally, Intercontinental Exchange is an American Fortune 500 company that builds, owns and operates global financial exchanges, clearing houses and data services. Its most popular entity is the New York Stock Exchange, which it acquired in late 2013. Thanks to equities participation enjoying record volume milestones following the paradigm shift of COVID-19, ICE stock would seem to enjoy tremendous relevance.

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When we talk about selling tickets to the game rather than betting on a certain outcome, it's difficult to ignore an enterprise like Intercontinental Exchange. Let's face it — it's a massive challenge to predict future price discovery. However, given the explosion in popularity of investing and options trading, there's a reasonable expectation that ICE stock may march higher over the long run.

That said, the near-term picture is equally as fascinating. On a technical level, ICE stock is enjoying a resurgence, with the ticker rising almost 12% since the end of last month. But on a year-to-date basis, the performance has been poor, as Intercontinental Exchange has lost 15% of market value. Despite the red ink, there's good reason to be optimistic.

In finance terms, experts call it mean reversion. Essentially, ICE stock may have been excessively beaten down. Since the crimson wave likely would have shaken out the weak hands of the market, ICE sits in an exhaustive state. Subsequently, any bit of good news may have a disproportionately positive impact on the security.

Mean reversion isn't a new concept but with modern technology, we can empirically measure expected outcomes.

While it's not controversial to mention mean reversion, the theory deserves more than an assertion by fiat. My presupposed framework is that the balance of order flow — specifically the balance of up/down weeks over a 10-week time period — influences the potential outcome of distributions.

How do I know this? Well, frankly, I don't know it as an absolute fact. But because modern equity markets are dominated by algorithmic, rules-based trading, I believe it's more than plausible that when order-flow balance is skewed toward bullishness, the distribution of near-term outcomes would be different from a neutral or bearish balance.

At a topical level, my point is that ICE stock currently suffers from a bearish balance. Therefore, it's possible — and arguably likely — that trading algorithms view the ticker as a discount. If so, we would expect a higher probability of an upside response rather than a continuation of pessimism.

Indeed, the data that I collected appears to confirm this theory. In the last 10 weeks, ICE stock printed only three up weeks, leading to an overall downward slope. This 3-7-D sequence has flashed 17 times since January 2019. Over the next 10 weeks, the expected 10-week forward distribution lands between $129 and $157 (assuming a starting price of $137.67, Monday's close). Probability density peaks at around $147, thus indicating a bullish bias.

Now, had we held ICE stock at random for a 10-week long position, the expected distribution would be between $136 and $143, with probability density peaking at $139.20. Across the spectrum, bullish traders may expect an average positive variance of 5.6%. What's more, the range of outcomes isn't expected to be orderly and linear. Based on the inductive data, ICE stock is forecasted to truly pick up on week 6 after the flashing of the aforementioned signal. At that point, the median expected outcome is a little over $145.

Earlier, I mentioned that ICE stock could be favorably mispriced and I intend to empirically justify that statement. First, based on the forecasted information above, the 140/145 bull call spread expiring Aug. 21 would seem to make the most sense. What's fascinating about this spread is the breakeven price of $142.50, which the market currently assigns a probability of profit of only 38.1%.

It's here where I believe a mispricing has happened. Under a Black-Scholes framework, the 38.1% probability is representative of the implied odds when factoring implied volatility under a risk-neutral, log-normal distribution of outcomes. In other words, if we were to assume that stocks moved in accordance with the Black-Scholes model, there's only a limited chance that ICE stock can rise through $142.50 on Aug. 21.