After Chewy, Inc. (CHWY) reported that it has missed analyst expectations for its fiscal second quarter earnings results, option traders are taking actions that suggest that they think the share price will move lower in the future. This may come as no surprise, considering the share price fell 9.2% the day after the announcement.

Chewy reported a net loss of $0.04 and revenues of $2.16 billion, lagging forecasts of a $0.01 net loss and $2.17 billion in revenue. In addition to missing expectations, Chewy's third quarter outlook fell short of Wall Street forecasts. Prior to the announcement, investors had kept Chewy's share price range bound just below its 20-day moving average.

Traders and investors had kept the share price of Chewy range bound before earnings; however, option trading activity after earnings indicate that investor confidence in CHWY’s share price going forward is waning. That’s because the price action has fallen to an extreme range, while option activity and the open interest implies that traders are selling call options and buying puts.

Key Takeaways

  • Traders and investors sold off shares of Chewy following the earnings announcement, as the stock fell 9.2%.
  • The share price of Chewy closed well below its 20-day moving average.
  • Put and call option activity appears to be positioned for the share price to continue to decline.
  • 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 a reversal in the earnings-based price decline.

Option trading is a literal 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 CHWY’s share price as of Sept. 3, illustrating the setup after the earnings report.

Earnings results for Chewy (CHW)

Current Trends

The one-month trend of the stock saw the share price rising to the upper third of the volatility range, before falling well below the 20-day moving average after the announcement, closing in the bottom 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 fallen to the lower extremes of the volatility range. This price move from CHWY shares implies that investors are losing confidence in the share price of CHWY 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 pessimism going into earnings, based on the price trend for CHWY closing below the 20-day moving average. 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 CHWY shares would move downwards 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 options traders implies that they consider Chewy 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 Sept. 17, the next monthly expiration date for options. The red-framed box represents the pricing that the put option sellers are offering. It implies a 70% chance that Chewy shares will close inside this range or lower by Sept. 17. 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 30% chance that prices could close below this red box, it appears that buyers are willing to take those long odds.

It is important to note that open interest on Friday featured over 142,000 call options compared to over 149,000 puts, demonstrating the bias that option buyers had. This normally implies that option traders expect downward price movement. After earnings, volatility has decreased dramatically, but the number of put options in the open interest increased. This signals a bearish sentiment. For strikes at the money and one step either direction, the call volume outweighs the put volume. Out-of-the-money put volume declines at a much slower rate than out-of-the-money call volume. However, it should be noted that the implied volatility of this call option volume is declining, indicating that call options, while still being traded in large volumes, are being sold more than purchased.

Option pricing for Chewy (CHW)

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 disparity with plenty of space to run upwards. 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 negative movement from the report, the share price moved less to the downside than it did after the last earnings report.

Volatility pattern for Chewy (CHW)

These support and resistance levels show a large range of support and resistance for prices. As a result of this, it is possible that there could be a large move in either direction in the near future. After the previous earnings announcement, Chewy shares fell 5.8% in the day following and continued to fall the following week. Investors may be expecting a similar 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 upside.

Wrapping Up

Chewy missed analysts' expectations for both revenue and EPS. The company's third quarter outlook also fell short of Wall Street forecasts. The share price fell 9.2% the day after the announcement, moving to the lowest extremes of the volatility range, closing well below its 20-day moving average. Option traders appear to be selling calls and buying puts, which translates into a bearish outlook. This activity, however, does provide more room in the volatility range for an upward move in the share price in the future.