After Snap Inc. (SNAP) reported that it had beaten analysts' expectations for its second quarter earnings results, option traders are taking actions that imply that they think the share price will drift lower in the future. This may be surprising considering that the SNAP share price rose 23.8% the day after the report was announced. SNAP reported earnings per share (EPS) of $0.10 and $982.1 million in revenue, exceeding analysts' predictions for EPS of -$0.01 and revenue of $848.4 million. Notably, the company's average daily users increased 2 million more than what analysts expected.

Prior to the announcement, investors had kept the share prices of SNAP range bound, with a sizable number of put options in the open interest. Option trading volumes indicated that traders had been selling calls and buying puts; however, options activity after earnings suggests that traders are still pessimistic about SNAP's share price, even after the company demonstrably beat analysts' expectations. That's because the price action has risen to the top of the volatility range, with more room for a move downwards, while option activity implies that traders continue to sell calls and buy puts.

Comparing the price action between option trading activity and stock prices on the days following earnings shows some evidence to suggest that option traders may be pessimistic. This should be surprising considering SNAP's share price rose 23.8% the day after earnings, closing well above its 20-day moving average and reaching its all-time high. Additionally, put option activity increased, while call option activity decreased. This could happen because option traders believe that SNAP is overvalued at these elevated levels and will trend lower in the near term.

Key Takeaways

  • Traders and investors bought shares in SNAP after the earnings announcement as the stock gained 23.8%.
  • The share price of SNAP broke well above its 20-day moving average and reached its all-time high.
  • Put and call option activity appears to be positioned for the price to decline.
  • The volatility-based support and resistance levels allow for a stronger move downward than upward.
  • This setup creates an opportunity for traders to profit from a reversal in the earnings-based share price increase.

Option trading represents the activities of speculators who wish to profit from accurately predicting unexpected movement in an underlying stock or index, or investors who want to protect, or hedge, their long positions. The actions of these investors imply a forecast for the weeks ahead. That's because option trading is a literal bet on market probabilities – a bet made by traders that are, on average, better informed than most investors. The key to taking advantage of this insight is to understand the context in which the price behavior took place. The chart below depicts the price action for SNAP's share price on Tuesday, July 27, illustrating the setup after the earnings report.

Earnings results for Snap Inc (SNAP)

Current Trends

Over the course of the past month, the trend of the stock saw shares moving in a wide range, floating above and below the 20-day moving average, before rising 23.8% the day after the announcement. 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 risen from the middle portion of this range to the upper bounds. This price move from SNAP shares implies that investors are confident in the stock's share price going forward.

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.

Chart watchers can recognize that traders were expressing pessimism going into earnings, based on the price trend for SNAP falling below the 20-day moving average the week before the announcement. 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 SNAP would move downwards 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

The recent activity of option traders implies that they consider SNAP 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 SNAP shares will close inside this range or lower 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 32% 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 Tuesday featured over 811,000 call options compared to over 1,000,000 put options, demonstrating the bias that option buyers had, as traders favored puts over calls. This normally implies that option traders expect downwards price movement. After earnings, the volatility has decreased dramatically, but the number of put options in the open interest remains elevated, and the number of call options decreased. This signals that call options are being sold, rather than bought, creating a bearish sentiment. For the strikes at the money and one step either direction, the put open interest far outweighs the call open interest. 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 SNAP share prices will fall than those who believe share prices will rise.

Option pricing for Snap Inc. (SNAP)

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 lower. This suggests that option buyers believe there is a greater probability for the share price to move lower in the weeks following the report. Although investors and option traders expected negative movement from the report, the share price moved a larger distance than it did after the last earnings report.

Volatility pattern for Snap Inc. (SNAP)

These support and resistance levels show a large range of support and resistance for prices. As a result of this, it is possible that there can be a large move in either direction in the near future. After the previous earnings announcement, SNAP shares rose 7.5% in the day following and gradually rose the following week. Investors may not be expecting the same kind of 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 to the downside.

Wrapping Up

SNAP beat analysts' EPS and revenue predictions. The company also reported that its average daily users increased 2 million more than analysts' expectations. Investors expressed confidence in the company, buying shares and sending the share price to the high end of the volatility range on the charts. Option traders appear to be selling calls and buying puts, expressing a bearish outlook while collecting elevated premiums. The share price activity, however, does provide more room in the volatility range for a downward move in the share price going forward.