After Texas Instruments Incorporated (TXN) reported that the company had beaten estimates for its second quarter earnings results, option traders are taking actions that imply they think the share price will drift higher in the future. This may come as a surprise considering that the TXN share price fell 5.3% the day after the report was announced.

Texas Instruments reported earnings per share (EPS) of $2.05 and revenues of $4.58 billion, exceeding analysts' predictions calling for EPS of $1.83 and revenue of $4.47 billion. It should be noted that, amid a global chip shortage, TXN forecasted slowing revenue growth for the third quarter, which may hurt profit margins.

Before the announcement, investors had kept the share price of TXN range bound, with a large number of call options in the open interest. Option trading volumes indicated that traders had been buying calls and selling puts; however, option activity after earnings suggest that traders' confidence in TXN's share price going forward is rising. That's because the share price has found a support level yet remains well below the 20-day moving average, while option activity implies that traders are both buying calls and selling puts.

Comparing the price action between stock prices and option trading activity on the days after earnings shows some evidence to suggest that option traders may be optimistic. TXN's share price rose 3.5% the day of earnings, closing just below its 20-day moving average. However, the day after the announcement, the share price fell 5.3%. Additionally, call option activity has increased, while put option activity decreased. This could happen because option traders believe that TXN's share price fell too far and could rise higher in the near term.

Key Takeaways

  • Traders and investors bought shares in TXN following the earnings report as the stock gained 3.5%.
  • The share price fell 5.3% the day after earnings, closing further below its 20-day moving average.
  • Put and call option activity appears to be positioned for the price to rise from current levels.
  • The volatility-based support and resistance levels allow for a stronger move upward than downward.
  • 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 who want to hedge their long positions or speculators who want to profit from correctly predicting unexpected movement in an underlying stock or index. The choices of these investors imply a forecast for the weeks ahead. That is because option 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. The key to maximizing this insight is to understand the context in which the price behavior took place. The chart below depicts the price action for TXN's share price on Tuesday, July 27, depicting the setup after the earnings report.

Earnings result for Texas Instruments Incorporated (TXN)

Current Trends

The one-month trend of the stock saw shares moving above and below the 20-day moving average, before rising 3.5% on the day of the announcement and dropping approximately 5.3% the day after that. 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 remained in the middle range. This price move from TXN shares implies that investors may be ambivalent in the stock moving 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 concern going into earnings, based on the price trend for TXN falling below the 20-day moving average. 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 TXN would move upwards 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 TXN shares undervalued at the current level 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 69% chance that TXN shares will close inside this range or higher 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 31% 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 nearly 86,000 call options compared to roughly 107,000 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 decreased, and the number of call options increased. This signals that call options are being bought, rather than sold, 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 TXN share prices will rise than those who believe share prices will decline.

Option pricing for Texas Instruments Incorporated (TXN)

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 don't have a strong conviction about how the company will move in the weeks following the report. Although investors and option traders expected positive movement from the report, the share price moved less distance than it did after the last earnings report.

Volatility pattern for Texas Instruments Incorporated (TXN)

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, TXN shares fell 4.4% in the day following and gradually rose the following week. Investors may 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 upside.

Wrapping Up

Texas Instruments beat analysts’ predictions for EPS and revenue. The company's fiscal third quarter forecast implied slowing revenue growth amid a global chip shortage. Investors initially expressed confidence in the company on the day of earnings. However, this narrative changed the day after, as TXN's share price fell 5.3%. Option traders appear to be buying calls and selling puts, expressing a bullish sentiment in the face of the decline. This activity, however, does provide more room in the volatility range for an upward move in the share price going forward.