Optimistic traders have bid up the share prices for Applied Materials, Inc. (AMAT) ahead of its quarterly earnings announcement. There's no way to accurately predict the direction a stock will move after an earnings announcement. However, a comparison of the price action between stock prices and option prices shows that if Applied Materials shares fall, creating a reversion back to its 20-day moving average in the first few days after the announcement, downside-focused traders are in position to capture the best profits.

Key Takeaways

  • Traders and investors have driven the price of Applied Materials shares higher heading into the announcement.
  • Applied Materials' stock price has been closing well above its 20-day moving average.
  • Put options are priced for a smaller drop and call options for a larger gain. 
  • The volatility-based support and resistance levels are positioned better for a move lower.
  • This setup creates a greater opportunity for traders to profit if the price falls.

Option trading represents the activities of investors who want to protect their positions or speculators who want to profit from correctly forecasting unexpected moves in an underlying stock or index. That means option trading is literally a bet on market probabilities. By comparing the details of both stock and option price behavior, chart watchers can gain valuable insight, although it helps to understand the context in which this price behavior took place. The chart below depicts the price action for Applied Materials' share price and the setup leading into the earnings report.

Chart showing the share price performance of Applied Materials, Inc. (AMAT) before earnings

Current Trend

The one-month trend of the stock has the shares moving strongly higher. It is notable that Applied Materials prices were around $97 per share at the end of January and have continually pushed higher, closing at a high of $116.72 as the announcement day draws near. The price closed in the upper extreme region depicted by the technical studies on this chart. The studies are formed with 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 toward its upper extreme. This unusual price move for Applied Materials shares implies that investors remain very optimistic about the report ahead.

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 one to two weeks of trading on a daily chart.

In this context where the price trend for Applied Materials has been accelerating, chart watchers can recognize that traders and investors are expressing strong optimism going into earnings. That makes it important for chart watchers to determine whether the move is presaging investors' expectations for a favorable earnings report. One bit of evidence to support the idea that investors are expecting good news from the company report can be found in the comparison of the volatility range depicted on the chart by the purple lines and the purple box in the background. Prices have moved so optimistically that they are at the top of this range.

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, this channel indicator makes for an excellent visualization tool when charting historical volatility.

Trading Activity

Option traders recognize that Applied Materials shares are pushing higher 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 Feb. 19, the Friday after the earnings report is released. The green-framed box represents the pricing that the call option sellers are offering. It implies a 73% chance that Applied Materials 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 78% probability if prices go lower on the announcement. One item of note is that both the red and green boxes depict a price range larger than the move that Applied Materials shares made in the week following the previous earnings announcement. This implies that option buyers expect a positive move from this announcement.

Chart showing Applied Materials, Inc. (AMAT) call and put pricing

It is important to note that trading on Wednesday featured over 24,000 call options traded compared to roughly 9,500 put options, demonstrating the bias that option buyers had. It is more typical for stocks, in general, that put option volume makes up 33% of the total. The fact that only 28% of the Applied Materials option volume is traded as put options means that traders are bit more optimistic than normal about the coming earnings announcement.

Chart showing Applied Materials, Inc. (AMAT) volatility range

These support and resistance levels show a lot less support for prices if they should begin to fall and a lot more resistance for prices if they begin to rise. As a result of this, and because of the obvious bias that option buyers have toward good news, it is possible that bad news will catch investors by surprise and could generate an unexpectedly strong move. After the previous earnings announcement, Applied Materials shares rose over 11% in the days following. Because the price is so close to the top of the volatility range, there is a possibility that the price move that follows the coming earnings announcement may not be as large as last time. However, option traders seem to discount this, as is evident in the large call-to-put ratio.

Market Impact

The effect of Applied Materials' earnings report, all by itself, is usually negligible to the market, but because of the company's prominent position in the semiconductor industry, the report may become a bit of a bellwether to analysts. Applied Materials stock is not highly correlated with major market moves, but the price action may influence the perceived value of selected stocks in the technology sector, especially semiconductor companies such as Taiwan Semiconductor Manufacturing Company Limited (TSM), Intel Corporation (INTC), and Advanced Micro Devices, Inc. (AMD). With more than 60% of the S&P 500 Index (SPX) companies having reported earnings by now and a large majority of them beating estimates, it is quite possible that investors could expect a positive surprise. That would lift technology sector exchange-traded funds (ETFs) such as State Street's Technology Select Sector SPDR Fund (XLK) and the Nasdaq 100-tracking Invesco QQQ Trust (QQQ). 

The Bottom Line

Option traders on Applied Materials bought significantly more call options than is typical before the company's earnings announcement. If the company reports unfavorable earnings or guides lower for some reason, Applied Materials shares could fall hard because of the lack of support nearby in the volatility range. Right now, the call options for Applied Materials are pricing in a range of roughly 8% higher for the coming week, while put option traders are pricing in a smaller move around 5% lower. Traders are expecting excellent news and largely ignoring the possibility of a large drop in price.