Optimistic investors have started to bid up share prices of Johnson & Johnson (JNJ) ahead of its quarterly earnings announcement. There's no way to accurately predict the direction a stock will move after an earnings announcement. However, a comparison of the price action between stock prices and option prices shows that if JNJ shares fall, creating a reversion back to its 20-day moving average in the first few days after the announcement, downside-focused traders are in a position to capture the best profits.

A noticeable collection of put options remain in the open interest for JNJ and appear to be initiated as sell orders. Trading volumes indicate that traders have been selling puts and buying calls in anticipation of a positive earnings report. If JNJ surprises with a negative announcement, these bets could swiftly unwind, resulting in downward pressure on the price of JNJ.

Accurately predicting the direction a stock will move after an earnings report is extremely difficult. However, comparing the price action between option trading activity and stock prices shows that, if the company delivers a negative earnings report, Johnson & Johnson shares could fall significantly, diverging away from its 20-day moving average in the first few days after the announcement. This could happen because options are priced for an upward move, but unexpected poor news could catch traders by surprise and create a rapid decline in price.

Key Takeaways

  • Traders and investors have begun to drive the price of Johnson & Johnson's shares higher heading into the announcement.
  • Johnson & Johnson's share price recently fell toward and then bounced upward from its 20-day moving average.
  • Put options are priced for a smaller drop and call options for a larger gain.
  • The volatility-based resistance and support levels are positioned for a move in either direction.
  • This setup creates a greater opportunity for traders to profit if the price falls.

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 it's helpful to understand the context in which this price behavior took place. The chart below depicts the price action for JNJ's shares and the setup leading into the earnings report.

Earnings setup for Johnson & Johnson (JNJ)

Current Trends

The one-month trend of JNJ's stock has the share price bouncing off of a bottom support level and trending higher, as JNJ's share price rose well above its 20-day moving average in the month of July as the announcement draws closer. The price climbed from the lower end of the trading range to above the 20-day exponential moving average (EMA) as shown on this chart.

The studies are formed with 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 from near the bottom of the middle range to the upper bounds. This is an optimistic price move for Johnson & Johnson shares.

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 Johnson & Johnson moved higher during the previous month, chart watchers can recognize that traders and investors are expressing optimism going into earnings. That makes it important for chart watchers to determine whether the move is predicting investors' expectations for a favorable earnings report. One point of evidence to support the idea that investors are expecting good news from the company report can be found in the comparison of the volatility range depicted on the chart by the purple lines and the purple box in the background. Prices have moved optimistically but are not yet near the high of this range.

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 Johnson & Johnson shares are trending higher 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 call option sellers are offering. It implies a 67% chance that JNJ shares will close inside this range by the end of the week if prices continue to rise. The red box represents the pricing for put options with a 36% probability if prices go lower on the earnings report announcement.

It is important to note that the open interest for JNJ featured over 220,000 call options compared to nearly 170,000 put options, demonstrating the ambivalence that option buyers had. Considering that call options are only slightly more represented than put options suggests that option traders are not expecting a significant move in either direction, as shown in the chart below.

Option pricing for Johnson & Johnson (JNJ)

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. It is notable in this chart that the call option and put option pricing are in such a close range, with plenty of space on either side to run. This suggests that options buyers don't have a strong conviction about how the company will report. A surprising report could push prices dramatically in either direction.

Volatility pattern for Johnson & Johnson

These support and resistance levels show more support for prices if they should begin to fall and less resistance for prices if they begin to rise. As a result, it is possible that bad news will catch investors by surprise and could generate an unexpectedly strong move. The rapid move higher in prices may be driven by analysts who have discovered good reasons to expect a favorable report. After the previous earnings announcement, Johnson & Johnson shares rose less than 1% in the days following. A much bigger downside move could be the result if investors' expectations are not fulfilled.

Market Impact

The effect of Johnson and Johnson's earnings report is influential to the market because of the company's key connection to the healthcare sector. JNJ shares typically make mild moves after earnings, so the result doesn't move index prices directly.

However, no matter what the report says, it will likely have a significant impact on stocks in the healthcare sector. A key factor to pay attention to will be how the ongoing rollout of the COVID-19 vaccine affects the stock's bottom line. A positive report could lift other stocks in the sector such as Pfizer Inc. (PFE), Eli Lilly and Company (LLY), or AbbVie Inc. (ABBV). It would also affect exchange-traded funds (ETFs) such as State Street's Health Care Sector Index ETF (XLV) and potentially State Street's S&P 500 Index ETF (SPY).