Investors of Alibaba Group Holding Limited (BABA) have expressed concern, bidding down the share prices of the company ahead of its upcoming earnings announcement. At first look, it appears that option traders are expecting a move lower, as there are a sizable number of sold call options in the open interest. The unusual option trading may create a strong upward trend in the price action if BABA delivers a positive earnings surprise.

A growing collection of call options remains in the open interest for BABA, and option premiums are unusually elevated right now. The trading volumes indicate that traders have been selling calls and buying puts in anticipation of an unfavorable earnings report. Unwinding these bets could result in unexpected upward pressure on the share price of BABA.

Correctly forecasting the direction a stock will move after earnings is difficult. However, a comparison between option trading activity and the stock's price action shows that, if Alibaba delivers a positive report, the company's share price could rise significantly, potentially moving it closer to the 20-day moving average in the days after the announcement. This could happen because options are priced for a downward move, but an unexpected earnings beat could catch traders by surprise and create a swift rise in share price.

Key Takeaways

  • Investors and traders have bid down Alibaba's share price to an extreme range headed into the earnings announcement.
  • The share price has been closing well below its 20-day moving average.
  • Call and put pricing is predicting a stronger move downwards.
  • The volatility-based support and resistance levels allow for a larger move to the upside.
  • This setup creates an opportunity for traders to profit from unexpected earnings results.

Option trading is a literal bet on market probabilities. By comparing the details of both stock price and option behavior, chart watchers can gain valuable insight, although it helps to understand the context in which this price behavior took place. The chart below illustrates the share price action for BABA as of Friday, July 30. This created the setup leading into the earnings report.

Earnings pricing for Alibaba Group Holding Limited (BABA)

Current Trends

The one-month trend of BABA stock has the shares falling to an extreme range, as there has been significant investor fear regarding China's crackdown on its tech sector. It is notable that, over this time period, the highest BABA share price was nearly $230 in late June, while the lowest share price was roughly $180 in late July. The price closed in the lower region depicted by the technical studies on 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 moved from a high range to a lower range over one month. This price move from BABA shares implies that investors are not expecting a positive earnings result.

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 BABA has been falling to an extreme range, chart watchers can recognize that traders and investors are expressing pessimism going into earnings. In the week before earnings, BABA's share price fell well below its 20-day moving average. That makes it important for chart watchers to determine whether the move is reflecting investors' expectations for unfavorable earnings or not.

Option trading details can provide additional context to assist chart watchers in forming an opinion about investor expectations. Recently, option traders are favoring calls over puts by a significant margin, as the open interest on options has a greater number of calls than puts. A higher number of calls than puts generally expresses optimism that traders appear to be expecting that BABA will move higher after earnings. However, it should be noted that, while call option volume is rising, implied volatility is falling, which generally signifies that call options are being sold, which would reflect a bearish sentiment.

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 BABA shares are in an extreme 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 Aug. 6, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 36% that Alibaba shares will close inside this range by the end of the week if prices go higher. The red box represented the pricing for put options with a 33% probability if prices go lower on the announcement.

It's important to note that the open interest featured over 2.3 million active call options compared to roughly 1.7 million put options, demonstrating the bias that option buyers had, as over half of the trades were call options. This amount normally implies that call option traders expect a jump in price. As mentioned, implied volatility is falling for call options and rising for put options, so even though there is a higher percentage of call options in the total volume, these options appear to be sold. A far more bearish outlook is implied.

Option pricing for Alibaba Group Holding Limited (BABA)

The purple lines on the chart are generated by a 10-day Keltner Channel study set at four 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 plenty of space to run upwards compared to downwards. This suggests that option buyers don't have a strong conviction about how the company will report, even though calls are being traded over puts. Although investors and option traders do not expect it, a surprising report could push prices dramatically higher or lower.

Volatility pattern for Alibaba Group Holding Limited (BABA)

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, BABA shares fell by 6.2% the day of earnings and gradually rose the following week. Investors may be expecting the same kind of 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

China stocks have taken a beating recently, as investors are concerned with China's government cracking down on tech and private tutoring. As one of the top Chinese stocks, BABA's earnings could have a ripple effect on the rest of stocks from the country.

No matter what the report says, it will likely have a significant impact on stocks in the consumer cyclical sector. A positive earnings surprise could lift other stocks in the sector such as Amazon.com, Inc. (AMZN) or eBay Inc. (EBAY).