Options Corner: Chewy Stock Could Be Unreasonably Mispriced Following An Extended Downturn

Chewy Inc (NYSE:CHWY) on paper represents one of the most relevant publicly traded companies available right now. Report after report demonstrates that Americans love their pets, thereby creating tangible shifts in the broader care ecosystem. Not only that, a vast majority of U.S. dog and cat owners consider their furry friends as family members.

Unfortunately, CHWY stock just hasn't been getting the memo. While the market has been treating the equity well today, over the trailing year, it's down 13%. In the trailing five years, CHWY dropped 70%, with normalization from the COVID-19 pandemic putting a dent on the e-commerce specialist. Still, for opportunistic options traders, the red ink could be an invitation for speculation.

It's not necessarily about the strong fundamental narrative, though that cannot be ignored. While America's love affair with household pets has often reached meme-level absurdities, this passion is already priced into CHWY stock. Frankly, the market doesn't price facts — they price changes in facts or changes in expectations.

What has changed about Chewy? I would argue that primarily, it's the value of CHWY stock. While outside pressures like economic challenges have certainly weighed on the business, the core proposition and catalyst remain largely undisturbed. Therefore, my speculation is that CHWY will be viewed as a discount, eventually sending the share price higher.

How can I be so sure? Obviously, nobody knows what tomorrow will bring. That said, volatility is not an independent phenomenon. Where CHWY stock will go tomorrow will largely depend on what is happening to CHWY today. Colloquially, this is the Markov property of the financial market, where the present state shapes the possibility of future outcomes.

Using The Markov Property To Find Mispriced CHWY Stock Options

Let's switch subjects for a moment. Imagine that you're flying aboard an airliner. What are the chances that you'll land safely? Well, if you're on one of the major U.S. carriers on a routine domestic flight, flying represents one of the safest modes of transportation. However, if you're in a sanctioned country with an inebriated flight crew, your odds will change.

It's the same situation with the market. CHWY stock, like any other popular public security, is path dependent. Therefore, whatever happened to CHWY yesterday (however yesterday is defined) will almost certainly impact what will happen to CHWY today (however today is defined).

But how is that different from how Wall Street prices risk? Essentially, everybody prices risk the same way, using some variant of the Black-Scholes model. However, this methodology assumes that volatility is independent. Therefore, risk is mostly defined as the target price's distance to the current spot price — which doesn't always make sense.

Sure, a layup is easier to make than sinking a three-pointer, for the primary reason that with a layup, you're much closer to the basket. However, in real game situations, the path to the layup could be heavily defended. In that case, passing the ball to the open player standing outside the arc may represent the more probabilistically prudent effort.

Again, this is the Markov property in action and it has very real applications. Under normal circumstances, a long position in CHWY stock held for 10 weeks would typically range between $32 and $33.60, assuming a spot price of $32.52. However, the current state is not "normal" but rather highly pressured — and that's going to change the forward implications.

Specifically, CHWY stock in the last 10 weeks printed only three up weeks, thereby leading to a downward slope. Under this 3-7-D sequence, the forward 10 weeks would likely shift to between $28 and $45, with probability density peaking at around $38. Even over the next five weeks, prices under 3-7-D conditions would tend to terminate at around $37.

Empirically, then, we have a natural target to aim for.

Betting On A Turnaround

Due to the extended pessimism, market makers have a dim view on CHWY stock, which makes a contrarian position all the more enticing. I’m looking at the 35.00/37.50 bull call spread expiring Feb. 20, 2026. This trade requires CHWY to rise through the $37.50 strike at expiration, which the data indicates is a very real possibility.

If so, the maximum payout stands at nearly 372%. Breakeven lands at $35.53, adding to the probabilistic credibility of the wager.

Traders should realize that under the Black-Sholes model, CHWY stock hitting $37.50 by Feb. 20 is considered a low-probability affair, defined at only 13.39%. In probability density terms, CHWY would be aligned somewhere on the fat tail, indicating an unlikely outcome. However, under a hierarchical framework using the Markov property, CHWY reaching $37.50 would be considered a higher-probability event.

In other words, before every trade, there are at least two competing world views about what could happen. One of these perspectives doesn't even consider the path that led up to where the target security is today. Therefore, because CHWY stock is not under a normal behavioral state, I prefer the Markov property as the best possible explanation of market reality.

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