Investors of General Motors Company (GM) have slightly bid up the share prices ahead of the company's fiscal second quarter earnings report. At first glance, it appears that option traders are positioned for a negative move, as the number of sold call options is high in the open interest. The unusual option activity could create a strong upward trend in the price action if GM delivers a positive earnings surprise.
A sizable number of call options remain in the open interest for GM, and option premiums are currently at unusually elevated levels. Trading volumes indicate that traders have been selling calls and buying puts in anticipation of an unfavorable earnings report. Unwinding these bets could result in unexpected upward pressure on the share price of GM.
Correctly predicting the direction a stock will move following earnings is difficult. However, a comparison between the stock's price action and option trading activity shows that, if GM delivers a positive report, the company's share price could rise significantly, moving further above its 20-day moving average after the announcement. This is possible because options are priced for a move downwards, but unexpected good news could catch traders by surprise and create a rapid rise in share price.
- Traders and investors have slightly bid up the GM share price headed into the earnings announcement.
- 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 strong move downwards.
- This setup creates an opportunity for traders to profit from an unexpected earnings result.
By comparing the details of both stock price and option behavior, chart watchers can gain valuable insight, although it is imperative to understand the context in which this price behavior took place. The chart below illustrates the price action for the GM share price as of the morning of Tuesday, Aug. 3. This created the setup leading into the earnings announcement.
The one-month trend of GM stock has the share prices remaining near the bottom third of the volatility range, before rising above the 20-day moving average in the week before earnings. Over the past month, the lowest GM share price was around $52 in mid-July, and the highest share price was nearly $60 just a week before the monthly low. The price closed in the middle 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 risen above the 20-day moving average in the week before earnings. This price move from GM 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 GM has risen to an average range, chart watchers can recognize that traders' and investors' confidence is growing going into earnings. It is notable that, in the week before earnings, GM's share price rose above the 20-day moving average from a below average range. 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 help chart watchers form an opinion about investor sentiment. Recently, option traders are favoring calls over puts by a decent margin. Normally this volume suggests that traders are expecting a positive earnings report; however, it's necessary to understand the context of this volume.
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 GM shares have risen from a below average range to an 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 Aug. 6, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 36% chance that General Motors 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 24% probability if prices go lower on the announcement.
It's necessary to note that the open interest featured over 940,000 call options compared to roughly 685,000 puts. At first glance, this would illustrate that option buyers had a bias toward calls over puts. However, because the call option implied volatility is falling, it can be inferred that traders are selling these options rather than buying them. This implies that option traders expect a decline in share price. However, because the call box and put box are relatively equal in size, it tells us that the high percentage of call options being sold has only mildly pushed expectations lower.
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 upwards. This suggests option buyers don't have a strong conviction about how the company will report, even though call volume outweighs put volume. 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, 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, GM shares rose by 2% the day after earnings before falling 2.7% the next day and continuing to fall for the next week. Investors may be expecting a similar 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.
Long gone are the days when an older company such as GM was considered a benchmark of the economy. However, no matter what the report says, it will likely have a noticeable effect on stocks in the automotive industry. A positive report could lift other stocks in the industry such as Ford Motor Company (F) or Honda Motor Co., Ltd. (HMC). It could also affect exchange traded funds (ETFs) such as First Trust's NASDAQ Global Auto Index Fund ETF (CARZ) or State Street's S&P 500 Trust Index ETF (SPY).