After International Business Machines Corporation (IBM) announced that it had beaten its second quarter earnings estimate, options traders are taking action that imply they believe the stock price will rise over time. ‘to come up. This may come as a surprise given that IBM’s stock price rose less than 1% on the day the report was announced. Prior to the announcement, investors had driven down the price of the shares, with a significant number of put options in open interest.
Option trading volumes indicated that traders had bought put options and sold put options; However, options activity after earnings suggests traders are bullish that IBM may start trending higher. This is because the price action has broken resistance, while option activity involves traders selling both puts and buying calls.
A price action comparison between stock prices and options trading activity in the days following earnings shows some evidence to suggest that options traders could be cautiously bullish. IBM’s stock price fell less than 1% on earnings day, before climbing in after-hours trading and closing below its 20-day moving average the day after the announcement. In addition, both put and call options business increased. This could be happening because options traders believe IBM will find support at these high levels and not go down in the short term.
Key points to remember
- Traders and investors bought shares of IBM after the results were announced, with the stock gaining 1.5%.
- IBM’s share price has moved closer to its 20-day moving average, reversing the downward trend that began before the results were announced.
- The activity of puts and calls appears to be positioned for the price to continue to rise.
- Support and resistance levels based on volatility allow stronger downward movement than upward movement.
- This setup creates an opportunity for traders to profit from a further increase in the share price based on earnings.
Since options trading represents the activities of investors who wish to hedge their long positions or speculators who wish to profit from the correct prediction of unforeseen movements of an underlying stock or index, their choices involve forecasting. for the coming weeks. Indeed, options trading is literally a bet on the odds of the market – a bet made by traders who are, on average, better informed than most investors. The key to maximizing this insight is to understand the context in which the price behavior took place. The chart below shows the evolution of the IBM stock price on Tuesday, showing the pattern after the earnings report.
The one-month trend in the stock saw stocks break through support in early June and trend lower before falling less than 1% on the day of the announcement and rising 1.5% the next day. Price closed in the middle region represented by the technical studies on this chart.
The studies consist of indicators of the Keltner canal at 20 days. These describe price levels that represent a multiple of the Average True Range (ATR) for the stock. This chart helps to highlight how the price has moved, but has mostly stayed in an average range throughout the month. This price movement IBM stock implies that investors can gain confidence in IBM to move forward.
the Average True Range (ATR) has become a standard tool for describing historical volatility over time. The typical average duration used in its calculation is 10 to 20 periods, which includes two to four weeks of trading on a daily chart.
Chart watchers can recognize that traders were expecting a further decline in profits, based on IBM’s price trend approaching the bottom third of the range. Chart watchers can also form an opinion on investor expectations by paying attention to the details of options trading. Before the announcement, traders seemed to expect IBM to rise after profits.
the Keltner channel indicator displays a set of semi-parallel lines based on a 20-day simple moving average and an upper and lower line. Since the upper lines are drawn by adding a multiple of ATR to the average and the lower lines are drawn by subtracting an ATR multiple from the average price, this channel indicator makes a great visualization tool when charting. historical volatility.
It is important to note that the open interest on Tuesday had nearly 287,000 calls against around 230,000 puts, demonstrating the ambivalence of option buyers, with a percentage of call and put options. almost equal. This normally implies that options traders are expecting price movement but are unsure of the direction.
After earnings, volatility decreased significantly, but the number of put options in open interest increased more than the number of calls. This indicates that the put options are being sold rather than bought, creating a bullish sentiment.
For cash strikes and a two-way street, the sell volume far exceeds the call volume. The volume of out-of-the-money put options is shrinking at a much faster rate than the volume of out-of-the-money calls, which means more traders believe IBM stock prices will fall more than those. who believe that stock prices will rise. It could also be because put options are sold more out of the money as traders don’t think the stock price will go down but are still able to grab a lower risk premium.
The purple lines on the graph are generated by a 10-day Keltner Channel study set at four times the ATR. This metric tends to create highly correlated regions of strong support and resistance in price action. These regions appear when the channel lines make a noticeable turn during the previous three months.
The levels that the bends mark are annotated in the table below. It is noteworthy in this chart that the prices of the calls and put options are in such a close range, with plenty of room on either side to operate. This suggests that option buyers don’t have a strong belief in how the company will report. A surprising report could push prices dramatically in either direction.
These support and resistance levels show a wide range of support for the price. As a result, it is possible that there will be a big upward movement in the near future. After the previous earnings announcement, IBM stock rose less than 3.8% the next day and continued the trend the following week. Investors can expect the same type of price movement in the week following this announcement. Towards the middle of the volatility range, stock prices may rise or fall more than expected in the near term; however, there is more room in the volatility range to support an upward movement.
The effect of the IBM earnings report is important to the market due to the company’s key connection to the technology industry. IBM stocks generally move slightly after earnings, so the result does not directly affect index prices.
However, no matter what the report says, it will likely have a significant impact on stocks in the tech sector. As one of the first major tech companies to release its quarterly earnings report, IBM is helping set the tone for the industry as a whole. The market reaction to a positive report could affect the equally positive reports of other industry stocks such as Apple Inc. (AAPL), Microsoft Corporation (MSFT) and Cisco Systems, Inc. (CSCO). State Street’s Technology Sector Index ETF (XLK) fell 1.4% on the day the report was released, and State Street’s S&P 500 (SPY) ETF fell 1.5 %.