Investors of controversial video game retailer GameStop Corp. (GME) have bid up the share price ahead of the company's fiscal second quarter earnings announcement. At first glance, it appears that option traders are positioned for a negative move, as the large number of put options in the open interest is nearly double the amount of calls. The unusual option activity could create a strong downward trend in the price action if GameStop delivers a negative earnings surprise. 

The open interest for GME shows an increasing number of put options, and option premiums are at an unusually elevated level. Trading volumes indicate that traders have been buying puts and selling calls in anticipation of a lackluster earnings announcement. If these bets were to unwind, it could place unexpected upward pressure on the share price of GME.

Accurately predicting the direction a stock will move after earnings is difficult. However, a comparison between the stock's price action and option activity shows that, if GameStop delivers a positive report, the company's share price could rise, moving further above its 20-day moving average after the announcement. This could happen because options are priced for a downward move, but unforeseen good news could catch traders by surprise and create a rapid rise in share price.

Key Takeaways

  • Traders and investors have bid up the GameStop 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 downside. 
  • 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 unexpected earnings result.

A comparison between the details of both stock price and option behavior can grant chart watchers valuable insight. However, it is necessary to understand the context in which this price behavior took place. The chart below depicts the price action for the GME share price as of Sept. 7. This created the setup leading into the earnings report.

Earnings pricing for GameStop (GME)

Current Trends

Over the past month, the trend for GME stock has the share price falling below and rising well above its 20-day moving average, closing in the top third of the volatility range. In this time period, it's notable that the lowest GME share price was roughly $151 in early August, whereas the highest share price was $225 in late August. The price closed in the upper 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 GME 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 GME has closed above its 20-day moving average, chart watchers can recognize that traders and investors are expressing growing optimism going into earnings. It's notable that, in the week before earnings, GME's share price has slightly declined. 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 53,000 calls traded opposed to nearly 30,000 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 GME shares are in an above average 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 Sept. 10, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 39% probability that GME 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 30% chance if prices go lower on the announcement. 

It is necessary to note that the open interest featured over 257,000 calls to over 538,000 puts, demonstrating the bias that option traders had, as traders favored puts over calls. This reflects a bearish sentiment around GME earnings. However, because the call box and put box are relatively equal in size, it tells us that the high percentage of put options has only mildly skewed expectations lower. A far more complacent outlook is implied.

Option pricing for GameStop (GME)

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 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 put volumes outweigh call volume. Although investors and option traders do not expect it, a surprising report would push prices dramatically higher or lower.

Volatility pattern for GameStop (GME)

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, GME shares fell 27% the day after earnings and continued to fall the following week. Investors may be expecting a similar negative 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

GameStop is hardly a bellwether stock, but since the initial madness that drew attention to the company, the stock has been volatile and prone to violent swings in either direction. By market cap, GameStop's earnings shouldn't have a direct effect on indexes. However, with a dedicated following, GME's earnings should have an impact on stocks in the specialty retail sector.

A positive report could lift other stocks in the sector such as Best Buy Co., Inc. (BBY) or Ulta Beauty, Inc. (ULTA). However, it's more likely to have an effect on other popular online stocks such as AMC Entertainment Holdings, Inc. (AMC). It could also affect exchange traded funds such as iShares' Core S&P Mid-Cap ETF (IJH), First Trust’s Nasdaq Retail ETF (FTXD), or VanEck Vectors' Social Sentiment ETF (BUZZ).