Option traders are taking actions that imply they think the share price of Google parent Alphabet Inc. (GOOG) will rise in the future, after the company smashed analysts' estimates for its fiscal second quarter earnings results. This may come as a surprise considering that the GOOG share price fell less than 1% the day after the report came out.
Alphabet reported earnings per share (EPS) of $27.26 and revenue of $61.88 billion, exceeding expectations calling for EPS of $19.34 and revenue of $56.16 billion. Notably, the company saw a dramatic rise in advertising growth along with YouTube's revenue drawing close to Netflix, Inc.'s (NFLX) quarterly revenue. Before the announcement, investors had bid up the share price of GOOG, with a large number of put options being sold in the open interest.
Ahead of earnings, option trading volumes had indicated that traders had been selling puts and buying calls. Option activity after earnings suggest that traders' confidence in GOOG's share price going forward is rising. That's because the share price remains in an elevated range well above its 20-day moving average, while option activity implies that traders continue to sell puts and buy calls.
Comparing the price action between option trading activity and stock prices on the days after earnings shows some evidence to suggest that option traders may be optimistic. GOOG's share price fell less than 1% the day of earnings, remaining well above its 20-day moving average. Additionally, call option activity has increased, while put option activity has remained elevated. This could happen because option traders believe that Alphabet will continue to report solid financials, which could spur a rise higher in the near term.
- Traders and investors sold shares in GOOG following the earnings report, as the stock fell less than 1%.
- The share price gained less than half of a percent the day after earnings, closing well above its 20-day moving average.
- Put and call option activity appears to be positioned for the price to rise from current levels.
- The volatility-based support and resistance levels allow for a stronger move downward than upward.
- This setup creates an opportunity for traders to profit from a reversal in the earnings-based share price movement.
Option trading represents the activities of investors who want to hedge their long positions or speculators who want to profit from correctly predicting unexpected movement in an underlying stock or index. The choices of these investors imply a forecast for the weeks ahead. That is because option trading is literally a 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 this insight is to understand the context in which the price behavior took place. The chart below depicts the price action for GOOG's share price on Friday, July 30, depicting the setup after the earnings report.
The one-month trend of the stock saw shares closing well above the 20-day moving average, before falling less than 1% on the day of the announcement and continuing to incrementally fall the day after that. 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 remained in the highest range. This price move from GOOG shares implies that investors may be confident that it can regain its all-time high going forward.
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 optimism going into earnings, based on the price trend for GOOG reaching its all-time high in late July. 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 Alphabet stock would move upwards 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.
The recent activity of option traders implies that they consider Alphabet shares undervalued at the current level and have purchased call options as a bet that the stock will close within the box depicted in the chart between today and Aug. 20, the next monthly expiration date for options. The green-framed box represents the pricing that the call option sellers are offering. It implies a 68% chance that GOOG shares will close inside this range or higher by Aug. 20. So sellers are only mildly bullish. However, buyers are snapping up this pricing, suggesting that buyers consider these options underpriced. Since the pricing implies only a 32% chance that prices could close above this green box, it appears that buyers are willing to take those long odds.
It is important to note that open interest on Friday featured nearly 95,000 call options compared to just over 155,000 put options, demonstrating the bias that option buyers had, as traders favored puts over calls. This normally implies that option traders expect downwards price movement. After earnings, the volatility has decreased dramatically, but the number of put options in the open interest remains elevated, and the number of call options increased. Implied volatility for put options has been falling, which signals bullish sentiment.
For the strikes at the money and one step either direction, the put volume far outweighs the call volume. However, the implied volatility is falling. When options volume shows an increase in volume but a decrease in implied volatility, it is inferred that traders are selling these options. If volumes were increasing and implied volatility were increasing, it would signal that traders were buying options. The put option activity from Alphabet illustrates a bullish sentiment.
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. Although investors and option traders expected positive movement from the report, the share price moved less distance than it did after the last earnings report.
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 can be a large move in either direction in the near future. After the previous earnings announcement, GOOG shares rose 3.2% that day and gradually fell the following week. Investors may be expecting the opposite 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 downside.
Google parent Alphabet walloped analysts' expectations for EPS and revenue. The company's complete blowout of predictions included a drastic rise in advertising and YouTube revenue. This big earnings beat wasn't immediately expressed in GOOG's closing share price; however, option traders have been buying calls and selling puts, reflecting a bullish sentiment that prices could climb higher in the future. This activity, however, does provide more room in the volatility range for a downward move in the share price going forward.