After Microsoft Corporation (MSFT) exceeded analysts' expectations for its fiscal fourth quarter earnings results, the actions of option traders imply that they believe the share price will rise in the future. This may come as a surprise considering the MSFT share price fell less than 1% the day after the announcement.

Microsoft reported earnings per share (EPS) of $2.17 and revenue of $46.15 billion, beating analysts' predictions calling for EPS of $1.92 and revenue of $44.24 billion. Despite chip supply constraints cutting into Windows revenue from device makers, Microsoft provided optimistic revenue forecasts going forward. Prior to the announcement, investors had kept the share prices of MSFT elevated, with a sizable number of call options in the open interest

Option trading volumes indicated that traders had been selling puts and buying calls. Option activity after earnings suggests that traders are still optimistic about MSFT's share price after the tech giant beat analysts' expectations. That's because the price action has remained elevated, while option activity implied that traders continue to sell puts and buy calls.

Comparing the price action between option trading activity and stock prices on the days following earnings shows some evidence to suggest that option traders may be optimistic. This could be surprising considering MSFT's share price fell less than 1% the day after earnings, although it closed well above its 20-day moving average. Additionally, call option activity increased while put option activity decreased. This could happen because option traders believe that MSFT is undervalued at current levels and will trend higher in the near term.

Key Takeaways

  • Traders and investors sold shares in Microsoft after the earnings announcement, as the stock fell less than 1% the day after.
  • The share price of MSFT closed well above its 20-day moving average.
  • Put and call option activity appears to be positioned for the price to rise.
  • 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 is a literal bet on market probabilities—a bet made by traders that are, on average, better informed than most investors. The key to taking advantage of this insight is to understand the context in which the price behavior took place. The chart below depicts the price action for MSFT's shares on Friday, illustrating the setup after the earnings report.

Earnings result for Microsoft Corporation (MSFT)

Current Trends

Over the course of the past month, the trend of the stock saw shares moving in an extreme range, floating well above the 20-day moving average, before falling less than 1% the day after the announcement. 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 upper range. This price move from MSFT shares implies that investors are confident in the stock's share price going forward.

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.

Chart watchers can recognize that traders were expressing optimism going into earnings, based on the price trend for MSFT touching its all time high prior to the earnings announcement. 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 MSFT would move upwards 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

The recent activity of option traders implies that they consider Microsoft 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 call option sellers are offering. It implies a 70% chance that MSFT 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 30% 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 over 1.4 million call options compared to nearly 1.3 million put options, demonstrating the bias that option buyers had, as traders favored calls over puts. This normally implies that option traders expect upwards price movement. After earnings, the volatility has decreased dramatically, but the number of put options in the open interest remain elevated, and the number of call options is increasing. This signals that put options are being sold, rather than bought, creating a bullish sentiment.

For the strikes at the money and one step either direction, the call open interest far outweighs the put open interest. Out-of-the-money put option volume declines at a much faster rate than out-of -the-money call volume, signifying that more traders believe that Microsoft share prices will rise than those who believe share prices will fall.

Option pricing for Microsoft Corporation (MSFT)

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 lower. This suggests that option buyers believe there is a greater probability for the share price to move higher in the weeks following the report. Although investors and option traders expected positive movement from the report, the share price moved a smaller distance than it did after the last earnings report.

Volatility pattern for Microsoft Corporation (MSFT)

These support and resistance levels show a large range of support and resistance for prices. As a result, it is possible that there can be a large move in either direction in the near future. After the previous earnings announcement, MSFT shares fell 2.83% in the day following and continued to fall the following week. Investors may not be expecting the same 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.

Wrapping Up

Microsoft handily beat EPS and revenue predictions. While supply constraints cut into Windows revenue from device makers, the company still provided a record quarter, and even future guidance exceeded analysts' expectations. Investors took profits after the report was released, as the share price fell less than 1% the day after the report was released, but the price still remains well above its 20-day moving average.

Option traders appear to be buying calls and selling puts, which reflects a bullish sentiment. However, it should be noted that the share price activity provides more room in the volatility range for a downward move in the share price going forward.