Investors of Facebook, Inc. (FB) have expressed optimism ahead of the company's fiscal second quarter earnings announcement by bidding up the share price. On the surface, it appears that option traders are predicting a positive move, as there are a greater number of call options in the open interest than puts. The unusual option trading may create a strong downward trend in the price action if Facebook delivers an unfavorable earnings surprise.
A significant amount of call options remains in the open interest for Facebook, 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. If these bets were to unwind, it could result in unforeseen downward pressure on FB's share price.
It is difficult to correctly predict the direction a stock will move following earnings. However, a comparison between the stock's price action and option trading activity shows that, if Facebook delivers an underwhelming report, the company's share price could fall significantly, moving closer to its 20-day moving average in the days after the announcement. This could happen because options are priced for an upwards move, but unexpected poor news could catch traders by surprise and create a swift decline in share price.
- Traders and investors have kept the price of shares in a relatively tight range headed into the announcement.
- The price has been crossing its 20-day moving average but recently climbed above it.
- Put and call pricing is predicting a stronger upwards move.
- The volatility-based support and resistance levels allow for a move in either direction.
- This setup creates an opportunity for traders to profit from an unexpected result.
Option trading represents the activities of investors who desire to protect their positions, or speculators attempting to profit from accurately predicting unexpected moves in an underlying stock or index. That makes option trading a literal bet on market probabilities. By comparing the details of both stock price and option 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 the FB share price as of Monday, July 26. This created the setup leading into the earnings announcement.
Over the past month, the trend of FB stock has the shares falling below the 20-day moving average before rising into the extremes of the volatility range. It's notable that, during this one-month period, the lowest FB share price was near $336 in mid-July, whereas the highest share price was nearly $375, an all-time high, just a few days later. The price closed in the upper region depicted by the technical studies on 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 moved to a higher range in the week before earnings. This price move from FB shares implies that investors expect a positive earnings result.
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 FB has been rising to an extreme range, chart watchers can recognize that traders and investors are expressing optimism going into earnings. In the week before earnings, FB's share price reached its all-time high, before slightly pulling back the following Monday and continuing to drift closer to that high. That makes it important for chart watchers to determine whether the move is reflecting investors' expectations for a favorable earnings or not.
Option trading details can provide additional context to assist chart watchers in forming an opinion about investor expectations. Recently, option traders are favoring calls over puts by nearly 2.5-1 as the open interest on options has a greater number of calls than puts. Normally, this suggests that investors are expecting a positive earnings report and that traders appear to be expecting FB to move higher after earnings.
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.
Option traders recognize that Facebook shares are in an extreme range 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 July 30, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 33% that Facebook shares will close inside this range by the end of the week if prices go higher. The red box represented the pricing for put options with a 34% probability if prices go lower on the announcement.
It's important to note that the open interest featured over 1.1 million active call options compared to roughly 900,000 put options, demonstrating the bias that option buyers had, as well over half of the trades were call options. This amount normally implies that call option traders expect a jump in price. However, because the call box and put box are relatively equal in size, it tells us that the high percentage of call options traded has only mildly skewed expectations higher. A far more complacent outlook is implied.
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 a close range with plenty of space to run downwards compared to upwards. This suggests option buyers don't have a strong conviction about how the company will report, even though calls are being purchased over puts. Although investors and option traders do not expect it, a surprising report could push prices dramatically higher or lower.
These support and resistance levels show a large range of support and resistance for prices. As a result of this, 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, FB shares rose by 7.3% in the day following and gradually fell the following week, before rising back above the 20-day moving average. Investors may not be expecting the same kind of move in the price after this announcement. With plenty of room in the volatility range, share prices could rise or fall more than expected.
As a bellwether stock, Facebook's earnings can have a direct effect on index prices. No matter what the report says, it will likely have an impact on stocks in the communications sector.
As one of the biggest stocks in the world and one of the heaviest weighted stocks in many exchange-traded funds (ETFs), Facebook's earnings are pivotal. A positive report could lift major ETFs such as State Street's Communication Services Sector Index (XLC), State Street's S&P 500 Index ETF (SPY), or Invesco's QQQ Trust ETF (QQQ). Similarly, Facebook's earnings results could have an effect on other stocks in the sector, such as Google parent Alphabet Inc. (GOOG), Verizon Communications Inc. (VZ), or The Walt Disney Company (DIS).