After Johnson & Johnson (JNJ) reported that it had beaten estimates for its fiscal second quarter earnings results, option buyers are taking actions that imply they think the share price will continue to rise in the future. JNJ reported adjusted earnings per share (EPS) of $2.48 and revenue of $23.31 billion versus analysts expectations calling for EPS of $2.21 and revenue of $22.21 billion. This may come as a surprise considering that the JNJ share price rose less than 1% the day after the report was announced. Prior to earnings, investors had bid up the share prices of JNJ, with a sizable number of put options being sold in the open interest.
Option trading volumes indicated that traders had been buying calls and selling puts, and options activity after earnings suggest that traders are optimistic at the chances of JNJ shares trending higher going forward. That's because the price action has tested resistance, while the option activity suggests that traders continue to buy calls and sell puts.
A comparison of the price action between stock prices and option trading activity on the days following earnings shows some evidence to suggest that option traders might be cautiously optimistic. Even though JNJ's share price rose less than 1% after earnings, the buying moved prices further above its 20-day moving average after the announcement. Additionally, put option activity has eased, and call option activity increased. This could happen because options traders believe that JNJ will continue to move higher above pre-earnings prices.
- JNJ beat analysts' expectations on both earnings per share and revenue.
- Traders and investors still bought shares in JNJ following the earnings announcement, as the stock rose less than 1%.
- The share price of JNJ rose further above its 20-day moving average after the earnings report.
- Put and call option activity appears to be positioned for a drift lower despite the rise in share price.
- The volatility-based support and resistance levels allow for a slightly stronger mover downward than upward.
- This setup creates an opportunity for traders to profit from a reversal in the earnings-based share price rise.
Option trading can imply a forecast for the weeks ahead; it represents the actions of investors who wish to hedge their long positions or speculators looking to profit from correctly predicting unforeseen movement in an underlying stock or index. Options 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. Understanding the context in which the share price behavior took place is the key to maximizing this insight. The chart below depicts the price action for JNJ's share price on Thursday, July 22, illustrating the setup following the earnings report.
The share prices of the stock have remained in the upper portion of the middle range over the course of the one-month trend. Over the past month, JNJ rose to over $170 per share near mid-July and drifted lower as earnings approached, before finally rising less than 1% on the day of the announcement and less than 1% 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 moved around but mostly held in the average.
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 expecting an upwards move going into earnings, as JNJ's share price was trending above its 20-day moving average. 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 JNJ would move slightly up 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 JNJ shares undervalued 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 put option sellers are offering. It implies a 69% chance that JNJ 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 31% chance that prices could close below this green box, it appears that buyers are willing to take those long odds.
It is important to note that open interest on Thursday featured nearly 239,000 call options compared to roughly 185,000 put options, demonstrating the bias that option buyers had, as there were a greater number of calls than puts. This amount normally implies that option traders are unsure of their expectations for the share price going forward.
After earnings, the volatility has decreased dramatically, but the number of call options in the open interest remains greater than the number of puts. This signals that put options are being sold, rather than bought, creating a bullish sentiment. For the strikes at the money and several steps either direction, the put volume outweighs the call volume. Out-of-the-money call option volume declines at a much slower rate than out-of-the-money put volume, signifying that more traders believe that JNJ share prices will drift higher than those who believe share prices will head lower, closer to its 20-day moving average.
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 more space to run lower than higher. This suggests that option buyers may not have a strong conviction about how the company's shares will move in the weeks following the report. Although investors and option traders were expecting positive movement from the report, the share price moved a shorter 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, it is possible that there could be a large move in either direction in the near future. After the previous earnings announcement, JNJ shares rose by 2.3% in the day following and fell the following week. Investors may not be expecting the same kind of decline 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 downward.
Johnson & Johnson beat analysts' EPS and revenue expectations. As a result, investors expressed confidence in the company, buying shares and sending the share price higher above its 20-day moving average. Option traders appear to be buying calls and selling puts, expressing bullish sentiment. This activity, however, does provide more room in the volatility range for a downward move in the share price going forward.