After Berkshire Hathaway Inc. (BRK.B) reported that it had beaten analysts' predictions for its fiscal second quarter earnings results, option traders are taking actions that imply they think the share price will move lower in the future. This may come as a surprise considering that the share price rose less than 1% the day after the announcement.

BRK.B reported revenue of $64.4 billion and net income of $11.71 billion, both exceeding analysts’ expectations. Prior to the announcement, investors had kept the share price range bound, with a noticeable amount of call options in the open interest.

Option trading volumes indicate that traders had been buying calls and selling puts; however, option activity after earnings indicates that traders are losing confidence in BRK.B's share price going forward. That's because the price action broke resistance and has risen to the upper third of the volatility range, while option activity implies that traders are selling calls and buying puts.

Key Takeaways

  • Traders and investors bought shares of BRK.B following the earnings announcement, as the stock rose less than 1%.
  • The share price of BRK.B closed well above its 20-day moving average.
  • Put and call option activity appears to be positioned for the share price to fall.
  • 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 a reversal in the earnings-based share price increase.

Option trading is literally a bet on the probabilities of the market—a bet made by traders that are, on average, better informed than most investors. The key to maximizing insight into option trading is to understand the context in which the price movement took place. The chart below illustrates the price action for BRK.B's share price as of Aug. 9, illustrating the setup after the earnings report.

Earnings results for Berkshire Hathaway Inc. (BRK.B)

Current Trends

The one-month trend of the stock saw the share price remaining just above the 20-day moving average, with the exception of two days in mid-July, before closing in the upper third of the volatility range depicted by the technical studies on this chart.

These 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 from the middle portion of this range to the upper third. This price move from BRK.B shares implies that investors have gained confidence in the share price of BRK.B going forward.

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.

Chart watchers can recognize that traders were expressing optimism going into earnings, based on the price trend for BRK.B closing above its 20-day moving average, before rising 1.9% the day before the earnings announcement. Chart watchers can also form an opinion of investor expectations by paying attention to option trading details. Prior to the announcement, traders appeared to be expecting that BRK.B shares would move upwards after earnings.

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

The recent activity of option traders implies that they consider BRK.B shares overvalued and have bought put options as a bet that the stock will close within the box depicted in the chart between today and Aug. 20, the next monthly expiration date for options. The red-framed box represents the pricing that the put option sellers are offering. It implies a 68% chance that BRK.B shares will close inside this range or lower by Aug. 20. So sellers are only mildly bearish. However, buyers are snapping up this pricing, suggesting that buyers consider these options underpriced. Since the pricing implies only a 32% chance that prices could close below that box, it appears that buyers are willing to take those long odds.

It is important to note that open interest on Aug. 9 featured over 300,000 call options compared to over 199,000 puts, demonstrating the bias that option traders had, as over 60% of the options were calls. This normally implies that option traders expect upward price movement. After earnings, the volatility has decreased dramatically, but the number of call options in the open interest remains elevated.

For strikes at the money and one step either direction, the call volume outweighs the put volume, which would signify that more traders believe that BRK.B share prices will rise than those who believe share prices will fall. However, it should be noted that the implied volatility of this call option volume is declining, indicating that call options, while being traded in large volumes, are being sold more than purchased.

Option pricing for Berkshire Hathaway Inc. (BRK.B)

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 disparity with more space to run to the downside. This suggests that option buyers have a stronger conviction of the price moving lower in the weeks following the report. Although investors and option traders expected positive movement from the report, the share price moved less to the upside than it did after the last earnings report.

Volatility pattern for Berkshire Hathaway Inc. (BRK.B)

These support and resistance levels show a large range of support and resistance for prices. As a result, it is possible that there could be a large move in either direction in the near future. After the previous earnings announcement, BRK.B shares rose 1.54% in the day following and continued rising the following week. Investors may be expecting a dissimilar kind of move in price in the week after this announcement. With lots of room in the volatility range, share prices could rise or fall more than expected in the near term; however, there is more room in the volatility range to support a move to the downside.

Wrapping Up

Berkshire Hathaway beat analysts' expectations for both earnings per share (EPS) and revenues. The share price rose less than 1% the day after the announcement and has risen to the upper third of the volatility range, closing above the 20-day moving average. Option traders appear to be selling calls and buying puts, which translates into a bearish sentiment. This activity provides more room in the volatility range for a downward move in the share price in the future.

Option Trading Example

As a bet on market probabilities, unusual option activity can offer traders insight into investor sentiment toward the company and illustrate what "smart money" is doing with large volume orders. One way to capture the bearish sentiment reflected in the post-earnings activity of Berkshire Hathaway option traders would be to open a debit put spread.

A debit put spread, a type of vertical spread, is an option strategy which involves simultaneously buying and selling two put options with the same expiration date but different strike prices. Although there is an initial cost on the transaction, this strategy is based on the belief the stock will fall in price, making the purchased put option more valuable in the future. The best-case scenario would be for BRK.B's share price to fall to or below the strike price of the option sold. This would deliver the maximum amount of profit while limiting the risk.

For example, to capture the bearish sentiment, buying the Sept. 10 $290 put costs $8.10 and has a breakeven price of $281.90. Selling the Sept. 10 $280 put will deliver a credit of $2.42, with a breakeven price of $277.58. After buying the $290 put and selling the $280 put, the net debit for this trade is $5.68, or $568 per contract. The breakeven price of the trade at expiration is $284.32 (data snapshot as of 3:59 EDT, 8/9/2021). The chart below illustrates the setup for this particular debit put spread.

Berkshire Hathaway (BRK.B) example

No strategy is without risk. The maximum risk on this trade is the total debit paid for the trade, or $568 per contract. Because this strategy sells a put option with a lower strike than the one purchased, the potential profit is capped, as opposed to buying a naked put option. For this particular example, the maximum potential gain is $432. The potential return on risk for this trade can be calculated as $432 / $568 = 76%.