Investors have kept the share prices of Twitter, Inc. (TWTR) range bound ahead of the announcement of its second quarter earnings report. With a growing number of out-of-the-money call options in the open interest, it appears that options traders are positioned to anticipate a slight positive move. The unusual options trading may create a strong upward trend in the price action if Twitter delivers a positive earnings surprise.

A growing number of put options remain in the open interest for TWTR, with unusually high option premiums. The trading volumes suggest that, in anticipation of a positive earnings report, traders have been both buying calls and selling puts. If Twitter's earnings report does not meet market expectations, these bets could swiftly unwind, resulting in downward pressure on the share price.

It is difficult to accurately predict the direction a stock will move after earnings. However, a comparison of the price action between stock prices and option trading activity shows that, if the company delivers a negative report, TWTR shares could fall significantly, moving further below its 20-day moving average in the first few days after the announcement. This could happen because options are priced for a small move, but unexpected poor news could catch traders by surprise and create a rapid decline in price.

Key Takeaways

  • Traders and investors have kept the price of TWTR shares range bound headed into the announcement.
  • The price recently fell below its 20-day moving average.
  • Put and call pricing is predicting a stronger upwards move.
  • The volatility-based support and resistance levels allow for a move in either direction.
  • This setup creates an opportunity for traders to profit from an unexpected result.

Option trading represents the activities of speculators who want to profit from correctly forecasting unexpected moves in an underlying stock or index, or investors who want to protect their positions. 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 the TWTR share price as of Tuesday. This created the setup leading into the earnings report.

Earnings setup for Twitter (TWTR)

Current Trends

The one-month trend of the stock has seen the share price tease the upper bounds of the range but remain just above the 20-day moving average until recently. It's notable that, in June, share prices pushed toward the top of the range, only to pull back in the days before the announcement.

After staying steadily above the 20-day moving average, the price has fallen below that level, as indicated 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 near the top of the range to the middle. This is a pessimistic price move for Twitter shares.

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 Twitter has been holding in a middle range, chart watchers can recognize that traders and investors are expressing complacency going into earnings. In the week before earnings, the share price gradually rose, only to fall below the 20-day moving average the next week. That makes it important for chart watchers to determine whether the move is reflecting investors' expectations for a favorable earnings report or not.

Option trading details can provide additional information to help chart watchers form an opinion about investor expectations. Recently, option traders are favoring calls over puts by a slim margin, as the open interest on options has a greater number of calls than puts. This normally suggests that investors are expecting good news from the company report. However, in this circumstance, traders appear to be expecting that TWTR shares won't move strongly, up or down, 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 TWTR shares are average 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 23, 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 39% chance that Twitter 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 a 41% probability if prices go lower on the announcement.

It is important to note that the open interest featured over 686,000 call options active compared to roughly 500,000 put options, demonstrating the slim bias that option buyers had, as the call option percentage was only slightly higher than the puts. This unusually equal amount normally implies that option traders expect a move but aren't sure in which direction. However, because the call box and the put box are relatively equal in size, it tells us that the high percentage of call options traded has not skewed expectations higher. This circumstance implies a far more complacent outlook.

Option pricing for Twitter (TWTR)

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 on either side to run. 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 would push prices dramatically higher or lower.

Volatility pattern for Twitter

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, TWTR shares fell by 15% in the day following and continued to drop the following week, before gradually rising above the pre-earnings price in June. Investors do not seem to be expecting the same kind of move in price after this announcement. With lots of room in the volatility range, share prices could rise or fall more than expected.

Market Impact

TWTR shares typically make exaggerated moves after earnings, so the result might move index prices directly. However, no matter what the report says, it will likely have a significant impact on stocks in the Communication Services sector. A positive report could lift other stocks in the sector such as Facebook, Inc. (FB), Alphabet Inc. (GOOG), or Snap Inc. (SNAP). It would also affect exchange-traded funds (ETFs) such as State Street's Communication Services Sector Index ETF (XLC) and potentially State Street's S&P 500 Index ETF (SPY).