Pessimistic traders have pushed down the share prices for PepsiCo, Inc. (PEP) 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 PepsiCo shares jump, diverging away from the 20-day moving average in the first few days after the announcement, uptrend-focused traders are in a position to capture the best profits.
- Traders and investors have driven the price of PepsiCo shares lower heading into the announcement.
- PepsiCo's stock price has been closing well above its 20-day moving average.
- Put options are priced for a larger drop and call options for a smaller gain.
- The volatility-based support and resistance levels are positioned better for a move higher.
- This setup creates a greater opportunity for traders to profit if the price rises.
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 helps to understand the context in which this price behavior took place. The chart below depicts the price action for PepsiCo's share price and the setup leading into the earnings report.
The one-month trend of the stock has the shares remaining in a medium range with a slight downward trend. It is notable that, over the past month, PepsiCo fell to $136 per share in late January, with only a slight retracement as the announcement day draws near. The price closed in the middle region depicted by the technical studies 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 the lower extreme back to its average range and held in that range. This price move for PepsiCo shares implies that investors may be nervous for the upcoming report.
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 one to two weeks of trading on a daily chart.
In this context where the price trend for PepsiCo has been holding in a middle range, chart watchers can recognize that traders and investors are expressing uncertainty going into earnings. That makes it important for chart watchers to determine whether the move is reflecting investors' expectations for a less-than-favorable earnings report. One bit of evidence to support the idea that investors are expecting poor 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. Even though prices have remained in such a tight range, they are drifting toward the bottom half of the volatility range. This position for the price confirms that investors are pessimistic.
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, this channel indicator makes for an excellent visualization tool when charting historical volatility.
Option traders recognize that PepsiCo shares are 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 Feb. 12, 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 75% chance that PepsiCo 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 the same probability if prices go lower on the announcement.
It is important to note that trading on Tuesday featured over 7,000 call options traded compared to roughly 4,500 put options, demonstrating the bias that option buyers had. This 1.5:1 call-to-put ratio implies that option traders are nervous about how the stock will move, as shown in the chart below.
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 on either side to run. This suggests that option buyers don't have a strong conviction about how the company will report. However, the put option range is much larger than the call option range, suggesting that investors have their doubts about the company's results.
These support and resistance levels show a large range of support of resistance for prices. As a result of this, it is possible that any news, strongly bad or good, will catch investors by surprise and could generate an unusually large move. After the previous earnings announcement, PepsiCo shares fell by over 2% in the days following. Investors may be expecting the same kind of small move in price after this announcement. With lots of room on either side of the support and resistance levels, share prices could rise or fall more than expected.
The effect of PepsiCo's earnings report, all by itself, is likely negligible to the market at large unless the news is shockingly bad. However, no matter what the report says, it may have a significant impact on stocks in the consumer staples sector. With more than 50% of the S&P 500 having reported earnings by now and a large majority of the components beating estimates, it is quite possible that investors could be in for a positive surprise. This could lift consumer staples stocks and exchange traded funds (ETFs) such as the Consumer Staples Select Sector SPDR Fund (XLP).
The Bottom Line
Option traders on PesiCo favored call options by a relatively small margin over put options before the company's earnings announcement. Because option buyers more often prefer buying calls than puts (usually by a two-to-one margin), the current numbers for PepsiCo imply that investors are not expecting good news from the company.
However, if a bad report does not materialize, PepsiCo shares could jump substantially because of the lack of resistance nearby in the volatility range. Right now, the call options for PepsiCo are not pricing in a wide range, so traders are dismissing the possibility of a large jump in price. The volatility price range shows enough upside to strongly exceed the call pricing. However, PepsiCo shares are not known for making strong moves in the five days after an earnings announcement.