After Twitter, Inc. (TWTR) reported that it had exceeded analysts' predictions for its second quarter earnings results, option traders are taking actions that imply that they think the share price will drift higher in the future. This may come as a surprise considering that the TWTR share price fell 4.2% the day after the earnings announcement.
TWTR reported an earnings per share (EPS) of $0.20 and revenue of $1.19 billion, beating analysts' expectations calling for EPS of $0.07 and revenue of $1.07 billion. It is notable that Twitter guided third quarter revenue higher than analysts currently expect, as the company expects that revenue will grow faster than expenses. Prior to the announcement, investors had kept the share price of TWTR range bound, with a noticeable number of out-of-the-money call options in the open interest.
Option trading volumes indicated that traders had been selling puts and buying calls; however, options activity after earnings suggest that traders are still confident about TWTR's share price after the social media company beat analysts' expectations. That's because the price has found support just below the 20-day moving average, while option activity implies that traders continue to buy calls and sell 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 continue to be bullish. This should be mildly surprising considering that TWTR's share price fell 4.23% the day after earnings. However, call option activity remains elevated, while put option activity has decreased. This could happen because option traders believe that TWTR is undervalued at current levels and will trend higher in the near term.
- Traders and investors bought shares in TWTR after the earnings announcement, as the stock gained 3% the day of earnings before falling 4.2% the day after.
- The share price of TWTR fell below its 20-day moving average.
- Call and put option activity appears to be positioned for the price to increase.
- The volatility-based support and resistance levels allow for an equal move in either direction.
- This setup creates an opportunity for traders to profit from a reversal in the earnings-based share price decline.
Option trading represents the activities of investors looking to protect their positions or speculators who wish to profit from correctly predicting unexpected movement in an underlying stock or index. The actions of these investors and speculators imply a forecast for the weeks ahead, 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 TWTR's share price on Wednesday, July 28, illustrating the setup after the earnings report.
Over the course of the past month, the trend of the stock saw shares moving in a wide range, floating from the top of the volatility range to the middle, just below the 20-day moving average. The price closed in the middle 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 fallen from the extreme range of this chart to the middle bounds. This price move from TWTR shares implies that investors are not overwhelmingly confident in the stock's share price going 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 expressing optimism going into earnings, based on the price trend for TWTR rising above 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 TWTR would move upwards 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 Twitter 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 red-framed box represents the pricing that the call option sellers are offering. It implies a 70% chance that TWTR 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 30% 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 Wednesday featured over 760,000 call options compared to over 579,000 put options, demonstrating the bias that option buyers had, as traders favored calls over puts. This normally implies that option traders expect upward price movement. It should be noted that the trading volume on Wednesday featured calls favored over puts nearly 4-to-1.
After earnings, the volatility has decreased dramatically, but the number of call options in the open interest is rising, and the number of put options is decreasing. 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 open interest far outweighs the put open interest. 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 TWTR share prices will rise than those who believe share prices will decline.
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 in either direction. This suggests that option buyers believe there is a greater probability for the share price to move higher in the weeks following the report. Although investors and option traders expected positive movement from the report, the share price moved a smaller distance than it did after the last earnings report, which resulted in a 15% decline.
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 could be a large move in either direction in the near future. After the previous earnings announcement, Twitter shares fell 15% 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 slightly more room in the volatility range to support a move to the downside.
Twitter beat analysts' EPS and revenue expectations. The company also guided third quarter revenue higher while maintaining that revenue will grow faster than expenses. Investors expressed ambivalence, buying the shares the day of earnings and selling off a bit the day after, sending the price just below its 20-day moving average. Option traders appear to be buying calls and selling puts, expressing a bullish sentiment for the near term. The share price activity, however, provides equal room in the volatility range for a move downward or upward in the share price going forward.