Optimistic traders have bid up the share prices for Twilio Inc. (TWLO) ahead of its quarterly earnings announcement. But option traders are showing caution by hedging their bet. 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 Twilio shares fall, creating a reversion back to its 20-day moving average in the first few days after the announcement, downside-focused traders are in position to capture the best profits.

Key Takeaways

  • Traders and investors have driven the price of Twilio shares higher heading into the announcement.
  • Twilio's stock price has been closing well above its 20-day moving average.
  • Put options are priced for a smaller drop and call options for a larger gain. 
  • The volatility-based support and resistance levels are positioned better for a move lower. 
  • This setup creates a greater opportunity for traders to profit if the price falls.

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 Twilio's share price and the setup leading into the earnings report.

Chart showing the share price performance of Twilio Inc. (TWLO) before earnings

Current Trend

The one-month trend of the stock has the shares moving strongly higher. It is notable that, over the past month, Twilio prices were around $364 per share at the start of February and have continually pushed higher, closing at a high of $435 as the announcement day draws near. The price closed in the upper extreme 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 its lower range toward its upper extreme. This unusual price move for Twilio shares implies that investors remain very optimistic about the report ahead.

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 one to two weeks of trading on a daily chart.

In this context where the price trend for Twilio has been accelerating, chart watchers can recognize that traders and investors are expressing strong optimism going into earnings. That makes it important for chart watchers to determine whether the move is presaging investors' expectations for a favorable earnings report. One bit of evidence to support the idea that investors are expecting good 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. Prices have moved so optimistically that they are at the top of this range.

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, this channel indicator makes for an excellent visualization tool when charting historical volatility.

Trading Activity

Option traders recognize that Twilio shares are pushing higher 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. 19, 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 Twilio 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. One item of note is that both the red and green boxes depict a price range larger than the move that Twilio shares made in the week following the previous earnings announcement. This implies that option buyers on both sides expect a big move from this announcement.

It is important to note that trading on Friday featured over 10,000 call options traded compared to roughly 7,300 put options, demonstrating the bias that option buyers had. It is more typical for stocks, in general, that put option volume makes up 33% of the total. The fact that nearly 42% of the Twilio option volume is traded as put options means that traders are bit more nervous than normal about the coming earnings announcement – perhaps with good reason since the price is trading so close to the upper edge of the volatility range.

Chart showing Twilio (TWLO) call and put pricing

These support and resistance levels show a lot less support for prices if they should begin to fall and a lot more resistance for prices if they begin to rise. As a result of this, and because of the obvious bias that option buyers have toward good news, it is possible that bad news will catch investors by surprise and could generate an unexpectedly strong move. After the previous earnings announcement, Twilio shares fell over 8% in the days following. Because of the width of the volatility range, there is a strong possibility that the price move that follows the coming earnings announcement may be larger than last time. Perhaps that's why the percentage of put options traded is slightly elevated compared to market averages.

Chart showing Twilio (TWLO) volatility range

Market Impact

The effect of Twilio's earnings report, all by itself, is likely negligible to the market. The stock is not highly correlated with major market moves. However, the price action may influence the perceived value of selected stocks in the technology sector and especially within the software application industry group. With more than 50% of the S&P 500 Index (SPX) companies having reported earnings by now and a large majority of them beating estimates, it is quite possible that investors could expect a positive surprise from Twilio. This could lift technology sector exchange-traded funds (ETFs) such as State Street's Technology Select Sector SPDR Fund (XLK), and the Nasdaq 100-tracking Invesco QQQ Trust (QQQ).

The Bottom Line

Option traders on Twilio favored call options but by a narrower margin over put options than is typical before the company's earnings announcement. If the company reports unfavorable earnings or guides lower for some reason, Twilio shares could fall drastically because of the lack of support nearby in the volatility range. Right now, the call options for Twilio are pricing in a range more than 11% higher for the coming week, while put option traders are pricing in roughly the same move lower. Traders are not ignoring the possibility of a large drop in price. The volatility price range shows that call option trading has priced in the possibility for the stock going beyond current volatility ranges. This range has yet to constrict, leaving open the possibility for a continued upward move in prices.