Investors of American Eagle Outfitters, Inc. (AEO) have kept the share price range bound ahead of the company's fiscal second quarter earnings announcement. At first glance, it appears that option traders are positioned for a positive move, as the number of call options is greater than the number of puts in the open interest. The unusual option activity could create a strong upward trend in the price action if American Eagle Outfitters delivers a positive earnings surprise.

The open interest for AEO shows an increasing number of call options, and option premiums are at an unusually elevated level. Trading volumes indicate that traders have been selling puts and buying calls in anticipation of a positive earnings announcement. If these bets were to unwind, it could place unexpected downward pressure on the share price of AEO.

Accurately predicting the direction a stock will move after earnings is difficult. However, a comparison between the stock's price action and option activity shows that, if AEO delivers a negative report, the company's share price could fall, moving further below its 20-day moving average after the announcement. This could happen because options are priced for an upward move, but unforeseen poor news could catch traders by surprise and create a rapid decline in share price.

Key Takeaways

  • Traders and investors have kept the share price range bound ahead of the earnings report. 
  • The share price has recently been closing below its 20-day moving average. 
  • Call and put pricing is predicting a stronger move to the upside. 
  • The volatility-based support and resistance levels allow for a stronger move to the upside.
  • This setup creates an opportunity for traders to profit from an unexpected earnings result.

A comparison between the details of both stock price and option behavior can grant chart watchers valuable insight. However, it is necessary to understand the context in which this price behavior took place. The chart below depicts the price action for the AEO share price as of Sept. 1. This created the setup leading into the earnings report.

Earnings pricing for American Eagle Outfitters (AEO)

Current Trends

Over the past month, the trend for AEO stock has the share price rising above and falling below its 20-day moving average, closing in the bottom third of the volatility range. In this time period, it's notable that the lowest AEO share price was roughly $29 in late August, whereas the highest share price was $35 in early August. The price closed in the lower region depicted by the technical studies in this chart.

The studies are formed by 20-day Keltner Channel indicators. These depict price levels that represent a multiple of the Average True Range (ATR) for the stock. This array helps to highlight the way the price has fallen below the 20-day moving average in the week before earnings. This price move from AEO shares implies that investors' confidence is waning as the earnings report approaches.

Tip

The Average True Range (ATR) has become a standard tool for depicting historical volatility over time. The typical average length of time used in its calculation is 10 to 20 time periods, which includes two to four weeks of trading on a daily chart.

In this context where the price trend for AEO has closed below its 20-day moving average, chart watchers can recognize that traders and investors are expressing growing pessimism going into earnings. It's notable that, in the week before earnings, AEO's share price has steadily declined. That makes it important for chart watchers to determine whether the move is reflecting investors' expectations for favorable earnings or not.

Option trading details can provide chart watchers with additional context to help them form an opinion about investor expectations. Recently, option traders are favoring puts over calls by a narrow margin. On Tuesday, there were over 2,300 calls traded opposed to over 6,300 puts. Normally, this volume indicates that traders are feeling bearish toward the earnings report.

Tip

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. Because the upper lines are drawn by adding a multiple of ATR to the average and the lower lines are drawn by subtracting a multiple of ATR from the average price, then this channel indicator makes for an excellent visualization tool when charting historical volatility.

Trading Activity

Option traders recognize that AEO shares are in a below average range, and have priced their options as a bet that the stock will close within one of the two boxes depicted in the chart between today and September 3, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 37% probability that AEO shares will close inside this range by the end of the week if prices go higher. The red box represents the pricing for put options with a 33% chance if prices go lower on the announcement. 

It is necessary to note that the open interest featured over 100,000 calls to over 72,00 puts, demonstrating the bias that option traders had. That traders favored calls over puts. This reflects a bullish sentiment around AEO earnings. However, because the call box and put box are relatively equal in size, it tells us that the high percentage of call options has only mildly skewed expectations higher. A far more complacent outlook is implied.

Option pricing for American Eagle Outfitters (AEO)

The purple lines on the chart are generated by a 10-day Keltner Channel study set at 4 times the ATR. This measure tends to create highly correlated regions of strong support and resistance in the price action. These regions show up when the channel lines make a noticeable turn within the previous three months.

The levels that the turns mark are annotated in the chart below. What is notable in this chart is that the call and put pricing are in such a close range, with space to run either way but with more room to the upside. This suggests that option buyers don't have a strong conviction about how the company will report, even though recent put volumes outweigh call volume. Although investors and option traders do not expect it, a surprising report could push prices dramatically higher or lower.

Volatility pattern for American Eagle Outfitters (AEO)

These support and resistance levels show a large range of support and resistance for prices. As a result, it is possible that any news, surprisingly bad or good, will catch investors by surprise and could generate an unusually large move. After the previous earnings announcement, AEO shares rose 5.4% the day after earnings and continued to rise the following week. Investors may be expecting a similar positive move in the price after this announcement. With plenty of room in the volatility range, share prices could rise or fall more than expected.

Market Impact

AEO is a mid-cap stock, so it is unlikely that its earnings results will affect indexes directly. No matter what the report says, it's likely to have an effect on stocks in the apparel retail industry. A positive report could lift other similar-sized stocks in the industry such as Victoria's Secret & Co. (VSCO), Urban Outfitters, Inc. (URBN) or Boot Barn Holdings, Inc. (BOOT). It could also affect exchange traded funds (ETFs) such as iShares' Core S&P Mid-Cap ETF (IJH), Invesco's DWA Consumer Cyclicals Momentum ETF (PEZ), or iShares' Russell 2000 ETF (IWM).