While investors have kept the share prices range bound for Verizon Communications Inc. (VZ) ahead of its fiscal second quarter earnings announcement, they have also provided a short-term upward trend. On the surface, it appears that options traders are positioned to anticipate a positive move, as there have been a growing number of out-of-the-money call options in the open interest. The unusual option trading may create a strong upward trend in the price action if Verizon delivers a positive earnings surprise.
A sizable collection of call options remains in the open interest for VZ, and option premiums are unusually high right now. The trading volumes indicate that traders have been buying calls and selling puts in anticipation of a positive earnings report. Unwinding their bets could result in downward pressure on the price of VZ.
Accurately predicting the direction a stock will move after earnings is difficult. However, a comparison of the price action between stock prices and option trading activity shows that, if the company delivers a negative report, VZ shares could fall significantly, moving closer to the 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.
- Traders and investors have kept the price of shares in a relatively tight range headed into the announcement.
- The price has been closing just above 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 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 that 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 VZ share price as of Tuesday morning. This created the setup leading into the earnings report.
The one-month trend of the stock has the shares remaining in a fairly tight range. It is notable that, over the past month, the highest VZ share price was near $57 in mid-July, and the lowest share price was roughly $55 the following day. 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 moved around but mostly held in an average range all month. This price move from VZ shares implies that investors expect little change from the upcoming report.
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 VZ 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 VZ won't move strongly, up or down, after earnings.
The Keltner Channel indicator displays a set of semi-parallel lines calculated from the base of a 20-day simple moving average. 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.
Option traders recognize that VZ 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 57% chance that Verizon 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 43% probability if prices go lower on the announcement.
It is important to note that the open interest featured over 476,000 call options active compared to roughly 277,000 put options, demonstrating the bias that option buyers had, as only 36% of the trades were put options. This unusually low amount normally implies that call option traders expect a jump in price. 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.
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 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.
These support and resistance levels show a large range of support and resistance for prices. As a result of this, 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, VZ shares fell by 1.5% in the day following and continued to drop the following week, before ultimately rising above the pre-earnings price the week after that. Investors may be expecting the same kind of small move in price after this announcement. With lots of room in the volatility range, share prices could rise or fall more than expected.
Verizon shares typically make mild moves after earnings, so the result doesn't 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 AT&T Inc. (T), T-Mobile US, Inc. (TMUS), or Comcast Corporation (CMCSA). 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).