Optimistic traders have bid up the share prices for The Walt Disney Company (DIS) 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 Disney 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.
- Traders and investors have driven the price of Disney shares higher heading into the announcement.
- Disney 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 Disney's share price and the setup leading into the earnings report.
The one-month trend of the stock has the shares moving strongly higher. It is notable that, over the past month, Disney prices were $175 per share in mid-January and retraced slightly to $163 per share before pushing higher and closing at a high of $188.37 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 from the upper extreme to the lower extreme and back again toward its upper extreme. This unusual price move for Disney shares implies that investors remain very optimistic about the report ahead.
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 Disney 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 nearing the top of this range.
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.
Option traders recognize that Disney 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. 12, 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 75% chance that Disney 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 the same 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 Disney shares made in the week following the previous earnings announcement. This implies that option buyers on both sides expect a big move from this announcement.
It is important to note that trading on Tuesday featured over 139,300 call options traded compared to roughly 40,000 put options, demonstrating the bias that option buyers had. This three-to-one call-to-put ratio implies that option traders are expecting strongly positive news and giving a bias toward a move higher, as shown in the chart below.
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 option pricing is so much closer to the upper line of this study than the put option pricing is to the lower boundary. This suggests that buyers could run into eager sellers as the price approaches this line, potentially causing the price action to reverse.
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, Disney shares rose 6% in the days following. Because of the width of the volatility range, there is a strong possibility that the price move that follows the coming earnings announcement may be larger than last time.
Disney's earnings report may have a subtle impact on the larger market indexes. The price action of Disney shares is positively correlated with State Street's Dow Jones Industrial Average ETF (DIA). The company's business units are so heavily integrated with all aspects of the economy that the outcome of Disney's quarterly report may have implications for analysts who look for details to forecast economic direction.
However, no matter what the report says, it may have a significant impact on stocks in the consumer discretionary sector. With more than 50% of the S&P 500 having reported earnings by now and a large majority of the components beating estimates, it is quite possible that investors could be in for a positive surprise. This could lift consumer discretionary stocks and exchange traded funds (ETFs) such as the Consumer Discretionary Select Sector SPDR Fund (XLY) or the SPDR S&P 500 ETF Trust (SPY).
The Bottom Line
Option traders placing bets on Disney favored call options by a large margin over put options before the company's earnings announcement. Because option buyers more often prefer buying calls than puts (usually by only a two-to-one margin), the current numbers for Disney options imply that investors are expecting good news from the company.
However, if a bad-news report is published, Disney shares could fall substantially. The lack of support in the volatility range could extend an unexpected drop well below the put option pricing range. Right now, the put options for Disney are not reflecting the possibility of a large drop in price, so in the off chance that share prices drop, option traders may have a surprisingly profitable outcome.