After JPMorgan Chase & Co. (JPM) reported that it had beaten estimates for its second quarter earnings results, options buyers are taking actions that imply they think the share price will drift higher in the future. This may come as a surprise considering that the JPM share price declined 1.48% the day the report was announced.
Prior to the earnings announcement, investors had kept the share prices range bound, with a sizable amount of put options in the open interest. Option trading volumes indicated that traders had been buying puts and selling calls. However, options activity after earnings suggest that traders are optimistic that JPM could trend upwards going forward. That's because the price action seems to be holding support, while option activity implies that traders are both selling puts and buying calls.
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 JPM's share price fell 1.5% after earnings, the selling simply moved prices closer to its 20-day moving average after the announcement, but the stock closed solidly above that mark. Additionally, put option activity remained relatively stable, and call option activity increased. This could happen because options traders believe that JPMorgan is undervalued at current levels and that the share price will drift higher in the near term.
- Traders and investors still bought shares in JPMorgan following the earnings announcement as the stock tumbled 1.5%.
- The share price of JPM fell closer to its 20-day moving average but closed above it on the day after the earnings report.
- Put and call option activity appears to be positioned for a drift higher, despite the decline in share price.
- The volatility-based support and resistance levels allow for a stronger mover upward than downward.
- This setup creates an opportunity for traders to profit from a reversal in the earnings-based share price decline.
Because option trading represents the activities of investors who want to hedge their long positions or speculators who want to profit from correctly predicting unforeseen movement in an underlying stock or index, their choices 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 JPM's share price at the close of business Tuesday, illustrating the setup after the earnings report.
The share prices of the stock have remained in a wide range over the course of the one-month trend. Over the past month, JPM fell to $148 per share near the middle of June and drifted higher as earnings approached, before finally dropping almost 1.5% on the day of the announcement and 0.34% the day after that. 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 JPM shares implies that investors are not confident in JPM moving forward.
The 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 not expecting a significant move upwards or downwards going into earnings, based on the price trend for JPM holding in a middle range. 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 JPM would not move strongly, up or down, after earnings.
The Keltner Channel indicator displays a set of semi-parallel lines calculated from the base of a 20-day simple moving average. 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 JPM 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 JPMorgan shares will close inside this range or lower 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 trading on Wednesday featured over 85,000 call options traded compared to roughly 50,000 put options, demonstrating the bias that option buyers had – only 37% of the trades were put options. This low amount normally implies that call option traders expect a jump in price.
After earnings, the volatility has decreased dramatically, but the number of put options in the open interest remains greater than the number of calls. 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 volume far outweighs the put volume. 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 JPM share prices will drift higher than those who believe share prices will head lower.
The purple lines on the chart are generated by a 10-day Keltner Channel study set at 4 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 on either side to run. This suggests that option buyers don't have a strong conviction about how the company will move following the report. Although investors and option traders did not expect much movement from the report, the share price moved further 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, JPM shares rose by under 1% in the day following and started to drop the following week. Investors may be expecting the same kind of small 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 upward.
The effect of JPMorgan's earnings report is influential to the market because of the company's key connection to the financial sector. JPM 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 financial services sector.
As one of the first major companies to release its earnings report for the quarter, JPM plays a part in setting the tone for the market as a whole. How the market reacted to a relatively positive report could affect similarly potentially positive reports of other stocks in the sector such as Citigroup Inc. (C), Bank of America Corporation (BAC), or Wells Fargo & Company (WFC). State Street's Financial Sector Index ETF (XLF) fell 1.1% the day the report was released, and State Street's S&P 500 Index ETF (SPY) fell 0.46%.