After The Charles Schwab Corporation (SCHW) reported that it had missed profit estimates for its second quarter earnings results, options buyers are taking actions that imply they think the share price fell too far and that it will drift higher in the future. This may come as a surprise considering that the SCHW share price dropped 3.2% the day the report was announced. Prior to earnings, investors had kept the share prices range bound, with a sizable amount of both call options and put options in the open interest.
Option trading volumes indicated that traders had been buying calls and selling puts, and options activity after earnings suggests that this trend has continued, giving traders an optimistic outlook toward the SCHW share price. That's because the price action seems to be holding support, while the option activity suggests that traders are both buying calls and selling puts.
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 SCHW's share price fell 3.2% after earnings, the selling moved prices further from its 20-day moving average after the announcement. Additionally, put option activity remained relatively stable, and call option activity increased. This could happen because options traders believe that Schwab stock is undervalued at current levels and that the share price will drift higher in the near term.
- Traders and investors still bought Schwab shares following the earnings announcement as the stock tumbled 3.2%.
- The share price of SCHW fell further below its 20-day moving average 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.
Option trading can imply a forecast for the weeks ahead; it represents the actions of investors who wish to hedge their long positions or speculators looking to profit from correctly predicting unforeseen movement in an underlying stock or index. Options 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. Understanding the context in which the share price behavior took place is the key to maximizing this insight. The chart below depicts the price action for Schwab's share price on Tuesday, illustrating the post-earnings setup.
The share prices of the stock have remained in a wide range over the course of the one-month trend. Over the past month, SCHW rose to nearly $75 per share near the middle of June and drifted lower as earnings approached, before finally dropping 1.6% on the day of the announcement and 3.2% the day after that. The price closed in the lower 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 SCHW shares implies that investors are not confident in the stock moving forward.
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 not expecting a significant move upwards or downwards going into earnings, based on the price trend for SCHW 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 SCHW wouldn't move strongly, up or down, after earnings.
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.
The recent activity of option traders implies that they consider SCHW 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 68% chance that SCHW 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 32% 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 Tuesday featured over 97,000 call options compared to roughly 98,000 put options, demonstrating the bias that option buyers had, with more puts than calls. This high amount normally implies that put option traders expect the share price to continue to decline. 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 SCHW 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 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 higher. 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, SCHW shares dropped by 1% in the day following and started to rise 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 Charles Schwab's earnings report is influential to the market because of the company's key connection to the financial sector. SCHW 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. How the market reacted to a somewhat negative report could similarly affect potential earnings misses of other stocks in the sector such as Visa Inc. (V) or PayPal Holdings, Inc. (PYPL). State Street's Financial Sector Index ETF (XLF) fell 1.37% the day the report was released, and State Street's S&P 500 Index ETF (SPY) fell 0.78%.