The stock market is often described as a mechanism for “price discovery” of financial assets. Rather than have the value of businesses determined by a strict set of static formulas, it’s better to allow buyers and sellers to determine a fair price in an auction market.

By now, even the staunchest of communists must admit that free markets do a much better job of allocating assets than does a centralized government. The stock market operates in real time based on publicly available information, instead of behind the closed doors of bumbling bureaucrats.

However, price discovery can create huge distortions in the short run driven by fear and greed. When those emotions kick into overdrive, the price of a stock can bear little relation to the value of the underlying business.

Over time, those price disparities dissipate as emotions give way to reason. But in the near term, you can make a lot of money if you are willing and able to act on them when they arise.

Such an opportunity occurred a few weeks ago. On July 20, shares of credit card issuer Discover Financial Services (NYSE: DFS) fell more than 15% after the company released is fiscal 2023 Q2 results.

The problem was not the total revenue generated during the second quarter, which increased by 21% over the same period last year. Nor was it the size of its loan portfolio, which expanded by 19%.

And even though its diluted EPS (earnings per share) declined by 10% due to a higher net charge-off rate, that wasn’t the issue, either. What sent DFS sliding down the charts was the following disclosure: “Beginning around mid-2007, Discover incorrectly classified certain credit card accounts into our highest merchant and merchant acquirer pricing tier.”

Immaterial Impact

Certainly, any time a company reports an accounting irregularity there is reason for concern. Sometimes, it can be the tip of an iceberg involving some form of corporate malfeasance intended to boost profitability.

However, Discover also made clear that this mistake made very little difference in its operating performance: “Based on information available as of June 30, 2023, the Company determined that the revenue impact of the incorrect card product classification was not material to the consolidated financial statements of the Company for any of the impacted periods.”

If the company is to be believed, a big drop in its share price based on that information is unwarranted. And that’s when my Mayhem Trader stock screener gave me the green light to profit from this misguided attempt at price discovery.

That same day, I issued a trade alert recommending a call option trade on Discover. A call option increases in value when the price of the underlying security goes up.

Since DFS was plummeting due to panic, we were able to purchase the call option that expires on August 18 at the $110 strike price for $1 a share. At that time, its share price was below $102 after closing the day before above $121.

My timing was perfect. Just four days later DFS was back above $108, and our call option had doubled in value. I closed out that position for a 100% gain in less than a week!

Faulty Logic

If you think that trade was a fluke, consider this. Three weeks ago, I also closed out a 100% gain in a call option position on PC peripheral manufacturer Logitech (NSDQ: LOGI) less than a month after opening it.

In that case, the company’s CEO suddenly resigned with no explanation. Once again, Wall Street’s price discovery machine overreacted and dumped the stock with no regard to reason.

On Wall Street, the unscheduled departure of a c-suite officer usually portends some sort of unflattering revelation. Sometimes it is personal in nature, other times it’s about the business.

We still don’t know why he left in a hurry. But by now, it doesn’t matter to my Mayhem Trader readers. We opened and closed that position before an official explanation was given.

To be sure, trading options based on Wall Street’s price discovery chaos requires strong nerves and a steady hand. Your timing must be close to perfect, and you have to be willing to take the occasional loss.

I’ve been at this for more than forty years, so that doesn’t bother me. I learned a long time ago that I can’t be right every time. But I’ve also learned that I only have to be right more than I am wrong to make a lot of money at this game.

I believe Wall Street’s attempts at price discovery will serve up a lot more big winners for us this year. Everyone is on edge, waiting to see what the Fed is going to do next. At the same time, nobody knows what Russia or China might do next, either.

A high level of uncertainty creates an ideal trading environment for my Mayhem Trader options trading service. And right now, I’m seeing more quick profit opportunities than I have seen in a long time.

In fact, I suggest you consider a play that I’ve unearthed on the artificial intelligence (AI) super-boom. It’s an obscure “picks-and-shovels” stock that you won’t hear about on CNBC.

My AI investment lets you get started for about $100…and it generates regular cash payouts of up to $5,397. Want to learn more? Click here.

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