Investors of The Procter & Gamble Company (PG) have begun to express optimism ahead of the company's fiscal fourth quarter earnings announcement by steadily bidding up the share price. At first glance, it appears that option traders are predicting a positive move, as there are a noticeably higher number of call options in the open interest than puts. The unusual option trading could create a strong downward trend in the price action if PG delivers an unfavorable earnings surprise.

A sizable number of call options remain in the open interest for PG, and option premiums are unusually high right now. Trading volumes indicate that traders have been buying calls and selling puts in anticipation of a positive earnings report. Unwinding these bets could create unforeseen downward pressure on PG's share price.

Accurately predicting the direction a stock will move following earnings is difficult. However, a comparison between the stock's option trading activity and price action shows that, if PG delivers a disappointing report, the company's share price could fall significantly, moving closer to its 20-day moving average in the days after the announcement. This is possible because options are priced for a small move, but unexpected poor news could catch traders by surprise and create a rapid fall in share price.

Key Takeaways

  • Traders and investors have bid up the share prices to an elevated range headed into the earnings report.
  • The share price has recently been closing above its 20-day moving average.
  • Call and put pricing is predicting a stronger upwards move.
  • The volatility-based support and resistance levels allow for a stronger move to the downside.
  • This setup creates an opportunity for traders to profit from unexpected earnings results.

Option trading represents the activities of speculators attempting to profit from correctly predicting the unexpected moves in an underlying stock or index, or investors who wish to protect their positions. That makes option trading a literal bet on market probabilities. By comparing the details of option behavior and stock prices, chart watchers can gain valuable insight, although it's imperative to understand the context in which this price behavior took place. The chart below illustrates the price action for the PG share price as of Tuesday, July 27. This created the setup leading into the earnings report.

Earnings pricing for The Procter & Gamble Company (PG)

Current Trends

The one-month trend of PG stock has the shares rising above its 20-day moving average, rising into the top third of the volatility range. Over the past month, it's notable that the lowest PG share price was roughly $134 in late June, whereas the highest share price was roughly $140 in mid-July. 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 moved to a higher range in the week before earnings. This price move from PG shares implies that investors expect a positive earnings result.

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 PG has been rising to an elevated range, chart watchers can recognize that traders and investors are expressing optimism going into earnings. In the week before earnings, PG's share price rose to its one-month high before falling closer to the 20-day moving average, after which the share price climbed higher than the previous week. That makes it important for chart watchers to determine whether the move is reflecting investors' expectations for a favorable earnings or not.

Option trading details can provide additional context to assist chart watchers in forming an opinion about investor expectations. Option traders are favoring calls over puts by nearly 3-to-1 on Tuesday. Normally, this suggests that investors are expecting a positive earnings report and that traders appear to be expecting PG to move higher 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

Option traders recognize that PG shares are in an elevated range 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 30, the Friday after the earnings report is released. The green-framed box represents the pricing that call option sellers are offering. It implies a 39% chance that Procter and Gamble shares will close inside this range by the end of the week if prices go higher. The red box represented the pricing for put options with a 31% probability if prices go lower on the announcement.

It's important to note that the open interest featured over 221,000 active call options compared to roughly 136,000 put options, demonstrating the bias that option buyers had, as over 60% of the trades were call options. This amount normally implies that call option traders expect a jump in price. However, because the call box and put box are relatively equal in size, it tells us that the high percentage of call options traded has only mildly skewed expectations higher. A far more complacent outlook is implied.

Options pricing for The Procter & Gamble Company (PG)

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 downwards compared to upwards. This suggests that option buyers don't have a strong conviction about how the company will report, even though calls are being purchased over puts. Although investors and option traders do not expect it, a surprising report could push prices dramatically higher or lower.

Volatility pattern for The Procter & Gamble Company (PG)

These support and resistance levels show a large range of support and resistance for prices. As a result, it is possible that any news, surprisingly bad or good, will catch investors by surprise and could generate an unusually large move. After the previous earnings announcement, PG shares fell by less than 1% in the day following and continued to fall the following week, before rising back above the 20-day moving average. Investors may not be expecting the same kind of move in the price after this announcement. With plenty of room in the volatility range, share prices could rise or fall more than expected.

Market Impact

PG shares typically make small moves after earnings, so the result is unlikely to move index prices directly. However, no matter what the report says, it will likely have a direct impact on stocks in the consumer defensive sector. A positive report could lift other stocks in the sector such as The Coca-Cola Company (KO), PepsiCo, Inc. (PEP), or Walmart Inc. (WMT). It would also affect exchange-traded funds (ETFs) such as State Street's Consumer Staples Sector Index ETF (XLP) and potentially State Street's S&P 500 Index ETF (SPY).