Optimistic investors have bid up the share prices of Honeywell International Inc. (HON) ahead of its fiscal second quarter earnings announcement. With a growing number of out-of-the-money put options in the open interest, it appears that option traders are positioned to anticipate a negative move. The unusual option trading may create a strong downward trend in the price action of HON if the company delivers a negative earnings surprise.

A sizable collection of put options seems to be growing in the open interest for HON, and option premiums are unusually high right now. Option trading volumes indicate that traders have been selling calls and buying puts in anticipation of a negative earnings announcement. Unwinding these bets could result in upward pressure on the price of HON.

It is difficult to accurately forecast the direction a stock will move after earnings. However, a comparison of the price action between stock prices and option trading activity shows that, if the company delivers a positive report, HON shares could rise significantly, further above its 20-day moving average in the first few days after the announcement. This could happen because options are priced for a negligible move, but unforeseen good news could catch traders off guard and create a rapid rise in price.

Key Takeaways

  • Traders and investors have bid up the price of Honeywell shares headed into the earnings announcement.
  • The price has recently risen above its 20-day moving average.
  • Put and call pricing is predicting a stronger downward move.
  • The volatility-based support and resistance levels allow for a move in either direction but a stronger move downward.
  • This setup creates an opportunity for traders to profit from an unexpected result.

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 this price behavior is better understood with context. The chart below shows the price action for the HON share price as of Wednesday morning. This illustrates the setup leading into the earnings report.

Earnings setup for Honeywell International Inc. (HON)

Current Trends

The one-month trend of the stock has the shares moving in a wide range. Notably, over the past month, the highest HON share price was near $232 in mid July, and the lowest share price was roughly $215, in mid-June. 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 moved around but mostly held in an average range all month. This price move from HON shares implies that investors are expecting a positive result from the announcement.

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 the context where the price trend for HON has been moving toward the top of the range, chart watchers can recognize that traders and investors are expressing confidence going into earnings. In the week before earnings, the share price gradually rose, closing above the 20-day moving average the next week. That makes it important for chart watchers to determine whether the move is reflecting investors' expectations for a favorable earnings report or not.

Option trading details can provide additional information to help chart watchers form an opinion about investor expectations. Recently, option traders are favoring puts over calls by a noticeable margin, as recent option volume has a greater number of puts than calls. This normally suggests that investors are expecting poor news from the company report. However, in this circumstance, traders are expecting that HON may move strongly down after earnings.

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 HON shares are above average 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 23, 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 34% chance that Honeywell 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 40% probability if prices go lower on the announcement.

It is important to note that the open interest featured over 54,000 call options active compared to roughly 44,000 put options, demonstrating the bias that option buyers had, as calls outweighed puts by a narrow margin. This unusual, nearly equal amount of calls and puts amount normally implies that option traders are unsure of a jump in price. However, because the call box and the put box are relatively equal in size, it tells us that the nearly equal percentage of call and put options traded has not skewed expectations higher or lower. This circumstance implies a far more complacent outlook.

Option pricing for Honeywell International Inc. (HON)

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 much more space to run on the downside. This suggests that option buyers do not have confidence in HON earnings, even though calls are being purchased over puts. Although investors and option traders do not expect it, a surprising announcement would push prices dramatically in either direction.

Volatility pattern for Honeywell International Inc. (HON)

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, HON shares fell by 2.8% the day of earnings and continued to drop the following week. Investors may be expecting a different kind of move in price after this announcement. With lots of room in the volatility range, share prices could rise or fall more than expected, but there is more room in the range for prices to move lower, closer to the 20-day moving average.

Market Impact

HON shares typically make large moves after earnings, so the result could move index prices directly. However, no matter what the report says, it will likely have a significant impact on stocks in the industrial sector. A positive report could lift other stocks in the sector such as The Boeing Company (BA), General Electric Company (GE), or 3M Company (MMM). It would also affect exchange-traded funds (ETFs) such as State Street's Industrial Sector Index ETF (XLI) and potentially State Street's S&P 500 ETF Trust (SPY).