After PepsiCo, Inc. (PEP) 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 PEP share price increased 2.3% the day the report was announced.

Prior to the earnings announcement, investors had bid up the share prices, but there were still 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 suggests that traders are optimistic that PEP could continue to trend upwards going forward. That's because the price action has not yet seen a reversal, 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. PEP's share price rose 2.3% after earnings, and the activity has continued to move prices further above its 20-day moving average in the days after the announcement. Additionally, put option activity remained relatively stable, and call option activity increased. This could happen because options traders believe that PEP will find support at these elevated levels and will not decline in the near term.

Key Takeaways

  • Traders and investors bought shares in PepsiCo following the earnings announcement, as the stock gained 2.3%.
  • The share price of PEP rose higher above its 20-day moving average, continuing the upward trend started prior to the earnings announcement. 
  • Put and call option activity appears to be positioned for the price to remain elevated despite an already substantial increase.
  • The volatility-based support and resistance levels allow for a stronger mover downward than upward.
  • This setup creates an opportunity for traders to profit from a reversal in the earnings-based share price increase.

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 PEP's share price at midday Thursday, illustrating the setup after the earnings report.

Earnings setup for PepsiCo, Inc. (PEP)

Current Trends

The one-month trend of the stock has shares bouncing off a bottom support level and moving significantly higher, as PepsiCo climbed from $144 prior to almost $150 as earnings approached, before climbing 2.3% on the day of the announcement and rising an additional 1% the day after that. The price closed in the upper region depicted by 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 PEP shares implies that investors are very confident in PEP moving forward.

Tip

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 expecting a significant move upwards going into earnings, based on the price trend for PEP approaching the top of the 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 PEP would move upwards after earnings.

Tip

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.

Trading Activity

The recent activity of option traders implies that they consider PEP shares overvalued and have purchased put 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 red-framed box represents the pricing that the put option sellers are offering. It implies a 68% chance that PepsiCo shares will close inside this range or higher by Aug. 20. So sellers are only mildly bearish. 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 below this red box, it appears that buyers are willing to take those long odds.

It is important to note that open interest on Thursday featured nearly 130,000 call options compared to roughly 127,000 put options, demonstrating the ambivalence that option buyers had. The percent of calls and puts were nearly even, which normally implies that option traders expect price movement but are unsure of the direction.

After earnings, the volatility has decreased dramatically, but the number of call options in the open interest has become 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 one step either direction, the call volume far outweighs the put volume. Out-of-the-money call option volume declines at a much faster rate than out-of-the-money put volume, signifying that more traders believe that PEP share prices will drift lower than those who believe share prices will head higher.

Option pricing for PepsiCo, Inc. (PEP)

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 to run on the downside. 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 expect positive movement from the report, the share price moved further than it did after the last earnings report.

Volatility pattern for PepsiCo, Inc. (PEP)

These support and resistance levels show a large range of support for prices. As a result, it is possible that there could be a large move downward in the near future. After the previous earnings announcement, PEP shares rose by under 1.3% in the day following and continued the trend the following week. Investors may be expecting the same kind of move in price in the week after this announcement. Nearing the top of 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.

Market Impact

While PepsiCo is not typically thought of as a bellwether stock, its high profile makes it influential in the markets. Therefore, it may be that the positive news from the company could embolden investors and create a ripple effect through the markets. This could, in turn, have a recognizable impact on broad market exchange traded funds (ETFs) such as Invesco's Nasdaq 100 Index ETF (QQQ).