Optimistic investors have bid up the share prices of Bank of America Corporation (BAC) ahead of the company's fiscal third quarter earnings announcement. At first glance, it appears that option traders are positioned for a positive move, as options are priced for a move higher, and there are a greater number of call options in the open interest than puts. The unusual option activity could create a strong upward trend in the price action if Bank of America delivers a positive earnings surprise.

The open interest for Bank of America stock skews in the favor of call options, and option premiums are unusually high right now. Trading volumes indicate that traders have been buying calls and selling puts in anticipation of a positive earnings report. Unwinding these bets could place unforeseen downward pressure on the share price of BAC.

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

Key Takeaways

  • Traders and investors have bid up the share price ahead of the earnings report.
  • The share price has recently been closing above 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 downside. 
  • This setup creates an opportunity for traders to profit from an unforeseen earnings result.

A comparison between the details of both option behavior and stock price can grant chart watchers valuable insight. However, it is necessary to understand the context in which this behavior took place. The chart below illustrates the price action for the BAC share price as of Oct. 12. This created the setup heading into the earnings report.

Earnings pricing for Bank of America Corporation (BAC)

Current Trends

Over the past month, the trend for BAC stock has the share price rising above its 20-day moving average. In this time period, it's notable that the lowest BAC share price was roughly $39 in late September, while the highest share price was around $44 in early October. The price closed in the upper third 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 risen above the 20-day moving average in the week before earnings. This price move from BAC shares implies that investors' confidence is growing 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 Bank of America stock has closed above its 20-day moving average, chart watchers can recognize that traders and investors appear to be expressing growing confidence going into earnings. It's notable that, in the week before earnings, BAC's share price has slightly pulled back from recent highs. 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 calls over puts by a narrow margin. On Tuesday, there were over 98,000 calls traded opposed to nearly 91,000 puts. Normally, this volume indicates that traders are feeling bullish 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 BAC shares are in an above average range and have priced their options as a bet that the stock will close within one of the the two boxes depicted in the chart between today and Oct. 15, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 41% probability that BAC 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 37% chance if prices go lower on the announcement.

It is necessary to note that the open interest featured over 1.92 million calls to nearly 1.9 million puts, demonstrating the bias that option traders had, as traders favored calls over puts. The implied volatility for the higher volume of calls has been rising, indicating that traders are buying these options.

At the money and one strike in either direction, there are far more calls in the open interest than puts. This reflects a bullish sentiment around BAC earnings. However, because the call box and put box are relatively equal in size, it tells us that the higher percentage of purchased call options has only mildly skewed expectations higher. A far more complacent outlook is implied.

Option pricing for Bank of America (BAC)

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 plenty of space to run either way, but with more room to the downside. This suggests that option buyers don't have a strong conviction about how the company will report, even though recent call volumes outweigh put volume. Although investors and option traders do not expect it, a surprising report would push prices dramatically higher or lower.

Volatility pattern for Bank of America (BAC)

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, BAC shares fell 2.5% the day after earnings and continued to fall the following week. Investors may be expecting a dissimilar 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

Major bank earnings are significant in that they mark the start of the earnings season and can provide insight into overall economic performance for the quarter. As one of the first dominoes to fall, Bank of America earnings could affect indexes directly.

No matter what the report says, it will likely have an effect on stocks in the financial sector. A positive report could lift other stocks in the sector such as Wells Fargo & Company (WFC) or JPMorgan Chase & Co. (JPM). It could also affect exchange traded funds (ETFs) such as State Street's S&P 500 Index ETF (SPY), Invesco's KBW Bank ETF (KBWB), or State Street's Financial Sector ETF (XLF).